Almost uniformly, U.S. banks have been bolstering their loss reserves, planning for a potential recession next year in which more loans go bad.
But what are the assumptions behind the size of those projected losses? In some cases, banks have omitted from their public disclosures certain information that could help shed light on how realistic their estimates are. And when banks have provided details about their macroeconomic projections, the disclosures have revealed a fairly broad range of assumptions about the likely state of the U.S. economy next year.
The banks' assumptions are now facing scrutiny from Wall Street analysts as investors seek answers about how well prepared specific banks are for a downturn.
"Assessing adequacy of reserve levels is a tough exercise, given the wide variance in disclosures," Ken Usdin, an analyst at Jefferies, wrote in a research note this week.
Usdin wrote that the baseline economic scenario used by many banks — low-single-digit growth in real gross domestic product and an unemployment rate of roughly 4% — seems optimistic. The U.S. unemployment rate was 3.7% in October, and real GDP rose by 2.9% in the third quarter.
Particularly in the consumer lending realm, loan losses tend to rise along with unemployment, so the size of any future increase in joblessness has meaningful implications for banks' bottom lines.
For the fourth quarter of 2023, the median bank is assuming a 4.1% unemployment rate, according to a Nov. 21 report by Barclays analysts. For the full year, the median bank is projecting 0.8% year-over-year GDP growth.
The banks' downside outcomes are somewhat more worrisome. Those scenarios generally assume a low- single-digit contraction in real GDP next year, followed by growth the following year, and a peak in unemployment of around 7% in 2023, according to the Jefferies report.
The Jefferies analysis sheds light on the varying macroeconomic assumptions made by different large and midsize banks — as well as on the gaps in some of the banks' disclosures.
KeyCorp in Cleveland is projecting that the unemployment rate will be above 3.5% through the fourth quarter of next year, and that GDP will grow by 1% year over year in 2023, according to the Jefferies report.
Dallas-based Comerica offers a baseline scenario in which unemployment hits 4.0% in the first quarter of 2023, and then remains stable throughout the rest of the year, while GDP growth slows to less than 1%.
And Huntington Bancshares in Columbus, Ohio, has offered a baseline projection in which unemployment hits 4.0% in the fourth quarter of next year, and GDP climbs by 2.7% in the same period.
Some other banks are providing more pessimistic baseline forecasts.
Bank of America, for instance, is forecasting a weighted average unemployment rate above 5% in the fourth quarter of 2023. "So there's an inherent conservatism built into that reserving level," BofA Chief Executive Brian Moynihan said last month during the bank's third-quarter earnings call.
Wells Fargo projects that the weighted average unemployment rate in the fourth quarter of next year will be 6.1%, and that GDP will grow by 1.0% in the same period after falling by 1.1% during the second quarter.
Citizens Financial Group in Providence, Rhode Island, estimates that the unemployment rate will average 6% in 2023, and that GDP will decline by 0.5% next year under a baseline scenario.
It's possible that the differences between the more optimistic banks and their more downbeat counterparts are less significant than they might appear. Certain banks may be making qualitative adjustments to offset rosier scenarios, according to Usdin, who wrote that those banks lack detailed disclosures.
For example, the $179 billion-asset Huntington uses so-called probability weighting for different macroeconomic scenarios, but it doesn't disclose the number of scenarios it uses, according to the Jefferies report.
Mike Taiano, an analyst at Fitch Ratings, agreed that there is a lack of uniformity in banks' disclosures about the assumptions they use to calculate loss allowances.
"It doesn't get very granular, unfortunately," he said. "It would be nice to have that comparability."
Earlier this month, Fitch said that its 2023 outlook for the U.S. banking sector was deteriorating in comparison with the current year. The ratings agency is forecasting a mild U.S. recession in mid-2023, along with softness in asset quality relative to 2022.
Taiano said that banks' loan losses are likely to be higher than they might otherwise be as a result of strong loan growth this year, though
At the same time, Taiano said that as long as the Federal Reserve continues to raise interest rates in an effort to fight inflation, higher margins on loans will help to offset elevated losses. He also noted that the expected rise in bad loans comes after a period of unusually low loss rates during the COVID-19 pandemic.
"I think for the most part reserve levels seem pretty strong," Taiano said.
