By Jonathan Weil

It's been a tough several days for bank stocks. The pain could start showing up in banks' credit losses and earnings soon if one of the Federal Reserve's closely watched economic indicators is on the mark.

The KBW Bank Index is down around 9% this week. At the same time, the Federal Reserve Bank of Atlanta's running estimate for first-quarter gross domestic product, called GDPNow, is negative 2.4%. As recently as Feb. 19, the GDPNow model was estimating 2.3% growth. Two consecutive quarterly contractions would meet a commonly accepted definition of a recession. The U.S is a long way from that at the moment, but clearly the direction of economic forecasts is trending sharply downward.

Swiftly changing GDP forecasts could have a significant impact on lenders' credit loss estimates long before borrower defaults start rising in great numbers. Five years ago, new U.S. accounting standards took effect that were designed to make lenders recognize credit losses more quickly. From day one, they are supposed to continuously estimate their credit losses over the life of a given instrument, be it a loan or bond.

At large banks, that often means using mathematical models that directly incorporate forecasts of economic growth as a key input. For lenders that don't have large staffs of economists on the payroll, it has become common to outsource this part of their models to companies such as Moody's Analytics, which provide off-the-shelf tools to help clients estimate their expected credit losses.

Some banks provide granular details in their earnings presentations quantifying the impact that changes in economic forecasts had on the size of their credit-loss allowances for any given period.

For example, BankUnited, based in Miami Lakes, Fla., last year increased its credit-loss allowance to $223.2 million as of Dec. 31 from $202.7 million at the end of 2023. A bar chart in its yearend earnings presentation showed six different drivers of the change, both positive and negative. One of the positive drivers was management's economic forecast, which improved during the year and reduced the size of BankUnited's allowance by $15.8 million. That helped to offset other factors that caused the allowance to go up, such as growing losses on specific loans.

Not all banks provide the same level of disclosure about how their economic forecasts impact their credit-loss estimates and earnings. But they will be going through similar exercises when the first quarter closes. Soon they may need to start sharply revising the economic forecasts they use in their credit-loss estimates. This week's drop in banks' stock prices reflects some of that.

This item is part of a Wall Street Journal live coverage event. The full stream can be found by searching P/WSJL (WSJ Live Coverage).

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March 07, 2025 15:11 ET (20:11 GMT)

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