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Home›Cash›What JPMorgan’s allowance for loan losses says about the current recession

What JPMorgan’s allowance for loan losses says about the current recession

By Loriann Hicks
March 9, 2021
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Much has been said about how the current economic recession could be much worse than the Great recession from 2008-09. But aside from estimates of GDP and unemployment, it can be difficult to picture this. After all, aren’t some analysts and government officials predicting that the coronavirus recession will be much shorter than the Great Recession? Aren’t the banks in much better shape now? And didn’t the real estate market collapse in 2008?

The answer to all of these questions is yes. But the severity of the Coronavirus pandemic hit a lot harder and a lot faster than anyone might have expected. Indeed, the social distancing measures put in place to prevent the spread of COVID-19 have essentially crippled the economy. Even stores and industries such as airlines that still operate are not able to generate the same amount of revenue right now compared to normal times. While it’s difficult to compare the Great Recession to what’s happening now, you can get a better idea of ​​how the two stack up by looking at a key metric on JPMorgan Chase (NYSE: JPM) Financial state.

Image source: Getty Images.

Allowance for loan losses

If you’ve read about banking recently, you may have seen the term “allowance for loan losses” or “credit allowance” before. Both refer to the amount of money that banks set aside in a given quarter to cover loan losses that they believe could soon default. To be clear, the provision is not a guaranteed loss, but it is a projection of losses that could occur. In reality, loan losses may not come close to the allowance, or they may far exceed it. Either way, it’s a good indicator of financial stress at a specific time.

During the Great Recession, banks were widely criticized as one of the main sparks that ignited the flame of the recession. Today, banks are thought to be in good financial health. But despite massive problems in banks during the Great Recession, the allowance for loan losses at JPMorgan after just a quarter of the coronavirus – or really just a few weeks – was almost as high as at the height of the Great Recession.

JPMorgan Chase Allowance for loan losses Total assets
Q1 2009 $ 8.60 billion $ 2.08 trillion
Q1 2020 $ 8.29 billion $ 3.14 trillion

Source: JPMorgan Chase financial statements

As you can see, in the first quarter of 2009, when quarterly loan loss allowances peaked at many banks, JPMorgan declared its highest allowance of the recession at around $ 8.6 billion. In the first quarter of 2020, even with two solid months in January and February before the quarter took a sharp turn in March, JPMorgan made an equally large provision.

The bank is much bigger now in terms of total assets, although the bank is really closer to $ 2.7 trillion in assets compared to $ 3.1 trillion – JPMorgan is likely much bigger on paper due to of all the drawdowns on the credit of troubled companies in the first quarter.

In addition, the bank operates under the current new expected credit loss model (CECL), in which it forecasts loan losses over the life of a loan. Under the old accounting model, banks did not need to predict losses until they had a specific reason to believe that the credit quality of a loan had started to deteriorate. CECL probably provisioned the bank slightly more cautiously than it would have during the Great Recession. But even still, the bank increased its provision by nearly $ 6.9 billion in the linked quarter.

While the Great Recession surprised many – as most recessions do – the rate at which this supply has increased during this time looks like a slow burn compared to what happened during this coronavirus slowdown:

JPMorgan Chase Allowance for loan losses
Q4 2007 $ 2.54 billion
Q1 2008 $ 4.42 billion
Q2 2008 $ 3.46 billion
Q3 2008 $ 5.79 billion
Q4 2008 $ 7.31 billion
Q1 2009 $ 8.60 billion
Q2 2009 $ 8.03 billion
Q3 2009 $ 8.10 billion

Source: JPMorgan Chase financial reports

Despite the calamity of the Great Recession, the largest variation in the allowance was around $ 2 billion between quarters. Some of the other banks like Bank of America experienced much larger fluctuations in their loan loss provisions during the Great Recession. But I think JPMorgan is a good example to use because it was one of the best performing big banks during the Great Recession and didn’t have as many credit issues that are so different than it is now.

What it ultimately means

Provisions for loan losses are an indicator of financial stress over a three-month period because it shows how concerned a bank is about people’s ability to repay their debt. The fact that JPMorgan had a supply in the first quarter of 2020 – after just a few weeks of the coronavirus – that was as high as its supply at the height of the Great Recession shows how quickly the virus has affected the economy. Many banks plan to continue building their reserves in the second quarter. It’s unclear if provisions will be as high as in the first quarter, but a few more quarters like this last one and banks could start to see loan losses that look like the Great Recession. This shows why many experts are predicting such a severe recession in such a short period of time.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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