Banking executives and regulators have agreed on very little in the past year, but they have at least one bond: the belief that unemployment will peak just north of 10%.
What if their only shared prognostication proves wrong?
Concerns are growing among economists and analysts that those projections may be too optimistic. As a result, more thought is being given to how rising unemployment could further wound loan portfolios, how many banks would be able to withstand a rate that exceeds the generally accepted mark and whether the government would need to revisit its stress tests.
A great amount of uncertainty clouds the forecast, especially over how this year's stimulus package will affect recovery and employment. In a July survey of buy-side analysts by Friedman, Billings, Ramsey Group Inc., more than half the 191 participants forecast a peak rate of 11%. Though the Blue Chip Economic Forecast still hovers around 10%, more economists are ratcheting up their numbers to 11% or more.
"My view is that we may have higher unemployment than 10%," said Dimitri B. Papadimitriou, president of the Jerome Levy Economics Institute at Bard College. "A higher unemployment rate would certainly affect banks' earnings dramatically," he said, though the impact of the stimulus package remains a key wild card.
The most pessimistic observers note that unemployment reached 9.5% in June and that it is likely to inch higher again this month, to the highest level since 1983. The Midwest and West regions already have topped 10% unemployment, as have 15 states, according to June data from the Bureau of Labor Statistics.
The implications of further job losses are many, with the most immediate impact being credit quality, particularly on loans to consumers and retailers, observers said.
Paul Miller Jr., an analyst at FBR, wrote in a recent note to clients that he expects consumer and commercial loan losses to rise largely in step with the unemployment rate. If unemployment were to reach 12%, he forecasts that credit losses at several big banks could rise 25% to 67%, compared with losses off a 10% rate, depending on the bank and asset mix.
Michael Mayo, an analyst at Calyon Securities Inc., pressed Bank of America executives during their second-quarter conference call on what the impact might be if unemployment hit 11.5%, which is the mark being touted by Calyon's chief economist.
A continued rise in unemployment "clearly signals a broader weakness in the economy and continued weakness in consumer spending," responded Joe Price, B of A's chief financial officer. "I don't have a pinpoint answer for you as much as it would be additional costs that we would have to absorb, probably most pertinently on the consumer side. But that additional weakness would [also] roll through your commercial portfolios."
The longer unemployment rises, the more time it might take for credit pressures to subside. That would extend the period of time that banks must fund loan-loss reserves, in turn depressing earnings.
James Dimon, the chairman and CEO of JPMorgan Chase & Co., expressed that view during the New York company's earnings call. "Once unemployment levels off, you may see that number [of chargeoffs and reserves] actually start to come down a little bit," he said. "We don't know that, but there are good reasons to believe that."
Higher unemployment could also hurt capital levels, notably for the 19 big banks that were stress-tested in May. The most adverse scenario under the test relied on a peak unemployment rate of 8.9% this year and 10.3% next year. With that number in mind, nine banks were given passing grades, and many of those have since exited the government's Troubled Asset Relief Program.
Miller said the Federal Reserve Board could go back to the biggest banking companies, regardless of whether they passed or failed the exam, to encourage them to raise more capital. "The chief regulator would apply [the changes to] the stress test going forward," he suggested.
Terry Moore, the managing director of North America banking for Accenture Ltd., said smaller banks would also see capital further strained, which could prod more regulatory seizures or open-market sales. Moore said he already believes the number of banks will shrink by 25% between now and 2012.
Rising unemployment would also have greater implications on borrowing and lending, observers said.
Michael Mussa, a senior fellow at the Peterson Institute for International Economics, says that consumers and companies would further curtail borrowing. "There would be a lot less loan demand than would otherwise be the case," said Mussa, who remains among economists who see unemployment staying close to 10%.
Richard Anthony, the chairman and CEO at Synovus Financial Corp., said that is already happening in many of the Columbus, Ga., company's markets where unemployment has already hit double digits, though he hopes the stimulus packages provides some relief. "It would hurt us," he said of national unemployment hitting 11% or higher. "Your losses would go up and the balance sheet would shrink."
Many banking companies nonetheless are still committed to a forecast around 10%.
Capital One Financial Corp. on Thursday raised its unemployment forecast for the end of this year to 10.3%, from the 9.6% estimate it provided in April, though executives expressed optimism that layoffs appear to be growing at a slower rate.
Bank of America CEO Kenneth D. Lewis also held fast to a 10% projection during the company's earnings call, saying that such a rate remains among "the assumptions we use to run this company." With such an assumption, he still conceded that profitability would be a difficult task for the rest of the year, with some hope of a "return to more normalized earnings" in 2010.
