Stalemate in Washington brings turmoil to banks’ emergency planning

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The battle in Washington over the size and scope of a coronavirus relief package has piled on more uncertainty for the nation’s banks as they try to plan for an already wildly unpredictable future.

In calls with investors this week, executives of some of the biggest U.S. lenders voiced concern about the strength of the recovery, including the pace at which unemployed people are returning to work, and said that without more help from Congress, the economy’s struggles are likely to continue.

But they also slowed the pace at which they’re socking away funds to cover coming losses on their loan books, after beefing up their reserves by billions of dollars earlier this year. That’s a positive indication that the economy is recovering.

For a bank like JPMorgan Chase, the country’s biggest bank, that uncertainty about the direction of the economy makes it hard to confidently plan for the future.

“A good, well-designed stimulus package will simply increase the chance of better outcomes,” JPMorgan CEO Jamie Dimon told reporters on Tuesday. The bank has already braced itself for considerable losses, setting aside more than $34 billion in reserves. “If there are good outcomes, we’re over-provisioned by $10 billion,” Dimon said. “If there’s a double-dip [recession], we could be under-provisioned by $20 billion.”

The “base case” scenario that forms the foundation for JPMorgan’s planning only includes government economic relief through the end of the year. Bank of America isn’t counting on any more stimulus, while Citigroup is projecting more aid in the first quarter of next year. But the firms generally urged Congress to do more.

“The consumer has been extraordinarily strong through this crisis, and it’s not luck, and it’s not because they weren’t affected. It’s because of the CARES Act, specifically the unemployment assistance,” Wells Fargo CEO Charles Scharf said Friday at a conference hosted by the Institute of International Finance. “But those programs are running out.”

He also told investors, “The pace of job growth and the rebound in consumer spending have slowed, and the diminished pace of reopening and the end of some stimulus programs are presenting headwinds.”

If more stimulus isn’t coming, the worst-case scenario is worse, something that will heighten banks’ caution in lending to businesses and consumers that need help the most, for fear that they won’t be able to repay. For vulnerable corners of the economy, from poor people to heavily hit industries, more government money means an easier time paying the bills, which will translate to fewer hits to banks.

“Their earnings depend on the economy as do their losses,” said Karen Petrou, who advises financial firms in her role as managing partner at Federal Financial Analytics. “They’re the canaries in this coal mine.”

One bright spot is that banks have much larger loss-absorbing capital buffers than they did before the 2008 financial crisis because of a slew of new rules aimed at reducing their reliance on debt.

Ken Usdin, senior equity research analyst at the investment firm Jefferies, said banks in the second quarter were able to set aside massive sums to cover future losses while still handling a rush of panicked corporations drawing down their credit lines.

“There’s tons of liquidity in the banking system, and there is more than ample capital,” Usdin said.

The biggest banks have remained profitable, but that’s less because of traditional lending and more because of a bonanza in trading revenue after the Federal Reserve rescued financial markets that began freezing up in March. Smaller banks can’t count on that windfall, and all lenders will be squeezed over the long run because the central bank is planning to keep its benchmark interest rate near zero for years to come.

“The biggest banks offset some of their … losses with the trading income, but financial markets are still counting on a stimulus,” Petrou said. “If somebody pulls that punch off that table, we could see significant volatility.”

The political risk that there won’t be a smooth outcome to the November presidential election is another foreboding possibility for investors.

“Some kinds of volatility are good for bank earnings,” but only if markets don’t plunge too severely, she added.

Meanwhile, a recent Fed survey of bank loan officers found that banks were already tightening their lending standards.

“Nobody’s comfortable on credit at this point in the cycle,” said Brian Kleinhanzl, equity research analyst at Keefe, Bruyette & Woods. “We could go back into a recession again. I don’t know if it would be as deep as the first one, but it could be more painful,” particularly after the hit the economy has already taken.

For banks contemplating that possible future, “you probably wouldn’t go and take on as much risk … which just means that some people who want to borrow won’t be able to.”

That banks put aside less in reserves this quarter “is due at least in part to some encouraging economic data points, but at least some of that is likely a result of the previous policy response and without more assistance the arc of the recovery is far from certain,” said Isaac Boltansky, director of policy research at Compass Point Research & Trading.

“The deeply sad part is that Washington found a way to snatch defeat from the jaws of victory in its battle to blunt the economic fallout from the virus,” he said.

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