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This morning the Big 4 commercial banks – JP Morgan (JPM), Bank of America (BAC), Wells Fargo (WFC), and Citigroup (C) – kicked off 4Q22 earnings season. And while the current results looked fine, I expect the banks to run into problems in 2023.

Let’s start with Net Interest Margin. Banks make money by borrowing from various sources and lending out that money. The profit they make is the difference between the interest rate they pay and the one they get, or Net Interest Margin. As long term interest rates have risen of late, that has helped banks Net Interest Margin. For example, JPM’s Net Interest Margin increased to 2.47% in 4Q22 from 2.09% in 3Q22. That might seem insignificant but it adds up when you have trillions in assets and liabilities. However, I expect long-term interest rates to come down as we enter a recession this year, squeezing banks' Net Interest Margin, the core of their profitability.

Next, let’s turn to Credit Loss Provisions. This is the amount banks set aside to cover loans gone bad. They make estimates based on current trends and take a charge against earnings based on the number they come up with. Credit Loss Provisions increased marginally at the Big 4 in 4Q22. For example, JPM’s increased to $2.288 billion from $1.537 billion. Clearly, the Big 4 are anticipating some tougher times ahead – but I don’t think they are anticipating just how tough. The nasty recession I anticipate will put pressure on borrowers and lead to a significant increase in delinquencies and defaults. The second part of my bear thesis, therefore, is a significant increase in Credit Loss Provisions. Combined with Net Interest Margins being squeezed, this will put bank profits in a vice grip.

So while JPM may look reasonably valued at 12x 2022 EPs of $12, it looks more expensive if you expect bank earnings to shrink by 20-25% this year. I fail to see how banks' stocks won’t be hit by the nasty recession I see on the horizon.

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