Why many banks are preparing for an uptick of bad loans

It’s that time of year again: Public companies are releasing their earnings reports, so we’ll be hearing a lot from corporate America in the coming weeks. Big banks started reporting this past Friday, including JP Morgan Chase and Wells Fargo. More of them will report on Tuesday.

One theme that’s emerged among the big banks this year is that many of them have been setting aside more cash to cover bad loans — in other words, they’re getting cautious.

Banks always stock away some cash to cover loan losses. That’s because in good times and bad, banking involves a certain amount of risk.

“Loans go bad. Hopefully not at a high rate, but there are always some people or businesses that don’t pay back their loans,” said Julie Hill, dean of the University of Wyoming’s College of Law.

She said loan losses picked up a lot in the early years of the pandemic, and banks drew down their reserves to cover those losses.

So now that the economy has recovered?

“You’re seeing banks realizing that they’re away from the downturn of the pandemic, into more stable financial times, and they’re wanting to restore their reserves to prepare them for the next economic downturn,” she said.

But banks also have a few reasons to be concerned about certain types of loans.

A lot of banks are nervous about their commercial real estate loans, said Stephen Biggar, a bank analyst with Argus Research.

“Because the vacancies are pretty high. And then rates, of course, are much higher than where these loans had been taken out, you know, three and five years ago,” he said.

Biggar said banks are also keeping an eye on credit card debt — especially since delinquency rates have been rising.

“So there is quite a bit of credit card lending going on, people carrying a balance and so forth. And that’s usually not a terrific sign for the economy broadly,” he said.

Banks have also been working to ensure that their credit card customers can stay on top of their payments, said David Schiff, senior managing director with FTI Consulting.

One solution? Better communication.

“They’re using more effective collections techniques to remind customers about those payments, to work through solutions, to help customers to become current,” he said.

Schiff said banks are also trying to keep their commercial real estate loans healthy, too.

And now that interest rates are starting to fall, he said banks have been trying to work out better payment plans for properties that might be able to avoid going into default.

“Because they see where interest rates are going, and they’re going to try and hold on to the customers able to refinance at a more effective rate,” he said.

Even though the economy is uncertain right now, Schiff said banks need to keep making loans to stay profitable. And preventing loan losses is part of that strategy.