In 2022, Wall Street giants like JPMorgan, Citi, and Wells Fargo reported declining profits despite recording higher revenues. The divergence stemmed from banks aggressively building loss provisions, anticipating tougher times ahead as the Federal Reserve waged an inflation fight. While net interest income surged thanks to rapid rate hikes, banks chose to prioritize balance sheet resilience over short-term earnings. JPMorgan alone set aside $2.3 billion in Q3 2022 for potential loan losses.
The backdrop was an economy sending mixed signals. Consumer spending remained surprisingly robust even as inflation hit 9.1% and mortgage rates doubled. This spending surge boosted banks' interest income but came with hidden risks as households tapped debt to offset eroding purchasing power. Meanwhile, the labor market was robust as unemployment rates were low though the experts expected the unemployment rate to grow in future. Such contradictions left economists divided, with some predicting a soft landing while others warned of an imminent Tsunami.
On one side, net interest margins expanded dramatically. On the other, key business lines faced pressure such as mortgage originations at Wells Fargo shrank and investment banking fees plunged amid a dealmaking drought. This bifurcation forced banks into a delicate balancing act, profiting from rate hikes while preparing for their eventual economic downturn.
While delinquency rates remained benign in 2022, banks saw warning signs in rising corporate bankruptcies and shrinking savings rates. Their response of front-loading loss provisions followed lessons from 2008 that it is better to take modest earnings hits early than face catastrophic losses later. This conservative stance came at a cost as bank profits fell, but positioned the sector to weather potential downturns.
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