The largest banks in the U.S. will unveil their annual financial results by the end of the week. One contentious issue is likely to be the rise in non-performing loans – with some interesting Swiss parallels.

The provisions set aside by Julius Baer in November unsettled many investors. This 70 million Swiss francs measure was the result of one large loan exposure, probably in connection with the insolvency of the Austrian Signa Group.

The topic has made its way across to Switzerland and not just because of Signa. The number of corporate bankruptcies due to over-indebtedness rose by 8 percent last year to 7,335 companies, according to figures from Creditreform, the Swiss creditor association.

Provisions on a Downwards Track

By contrast, almost all Swiss banks have recently reduced their provisions for loan defaults, and this, along with bigger interest margins, has supported their results.

Compared with the U.S. and the eurozone, interest rates (and inflation) are still low here in Switzerland. This, along with solid economic expectations, have stabilized investor sentiment for the banking sector.

U.S. Banks Lay Their Cards on the Table

The parallels on the other side of the «pond» are intriguing, as the annual financial results of the largest American banks are about to be released.

In the U.S., the recent increase in investors’ optimism about the prospects of a soft landing have also strengthened confidence in the largest U.S. banks. But that could hit a snag. According to news agency «Bloomberg», analysts are expecting a jump in non-performing loans. Earnings are likely to have shrunk in the fourth quarter of 2023 due to unpaid debt and the impact of high interest rates.

According to estimates, the volume of non-performing loans at the four largest U.S. financial institutions – J.P. Morgan Chase, Bank of America (BofA), Wells Fargo and Citigroup – is expected to have grown to 24.4 billion dollars. That is almost 6 billion dollars more than at the end of 2022.

These are «bad loans» where the borrower has not made any payment within 90 days.

Plugging in the Gaps Running Into the Billions

Unpaid loans and the higher costs for deposits due to higher interest rates are expected to weigh on results. Some major banks also announced last December they plan to pay a one-off charge for a special levy to the Federal Deposit Insurance Corporation by the end of the year. This will plug the shortfall in the insurance fund of 18.5 billion dollars, which was caused by the collapses of Silicon Valley Bank and Signature Bank there.

Ongoing restructuring costs are also likely to weigh on results, especially at Citi and Wells Fargo. Citi is in the throes of its largest restructuring in years. Wells Fargo already announced in December that the bank will set aside 1 billion dollars for severance pay.

On average, the profits of the six major banks, including Goldman Sachs and Morgan Stanley, are expected to be 13 percent lower. BofA, Citi, J.P. Morgan and Wells Fargo will release their quarterly earnings reports on January 12, followed by Goldman Sachs and Morgan Stanley on January 16.

Private Loans Viewed With Concern

«Year-ahead outlooks get a lot of attention in fourth-quarter earnings calls,» Barclays Analyst Jason Goldberg told the British newspaper «Financial Times» (paid article). «I’m expecting that banks will indicate that the recent drop in net interest income will hit its trough this year.»

But even if the pressure on interest rates lets up, a sudden increase in unpaid loans could squeeze banks’ profits. The provisions for this have been reduced in the past few quarters. If provisions for bad loans unexpectedly jump, it could alarm investors. Two areas in particular that are being monitored with concern are mortgages for commercial real estate and personal loans.

This recalls memories of the U.S. banking crisis in spring 2023, which helped accelerate demise of the major bank Credit Suisse (CS) in Switzerland.

Are Reserves Big Enough?

Currently, bank’s reserves for loan defaults are significantly lower than at the start of the coronavirus pandemic. «Bank reserves are adequate right now because we are nowhere near the stress levels of back then,» Gerard Cassidy, a banking analyst at RBC Capital Markets, told the «Financial Times». «But have they reserved enough for an economic hard landing? The answer is no.»