Freedom: growth in distressed loans could limit U.S. banks’ profits

The volume of distressed loans issued to U.S. companies with high leverage rose by almost 90% year over year to $139.8 billion. This is close to the pandemic-period peak. Freedom Broker analyst Vladimir Chernov believes that deterioration in debt quality could increase banks’ provisioning costs and limit profit growth.

These are loans that trade in the secondary market at prices no higher than 80% of par. Such pricing reflects investors’ concerns about borrowers’ ability to repay obligations, but it does not by itself mean that all of these loans are already delinquent.

Investors demand higher yields for credit risk

Pressure is especially pronounced on the debt of the weakest borrowers. According to Chernov, yields on CCC-rated bonds reached 15.58%, and the spread over U.S. Treasuries exceeded 1,000 basis points—10 percentage points.

A CCC rating indicates a high risk of default. Elevated market yields reflect investors’ concerns and make new financing or debt refinancing more expensive for such companies.

Banks may need larger reserves

Chernov expects that the largest banks, including JPMorgan Chase (JPM) and Bank of America (BAC), may face higher allocations to reserves for potential credit losses. Both banks serve retail and corporate clients, provide lending, and support transactions in the capital markets.

The analyst pays particular attention to loans to highly leveraged companies and financing for the technology sector. If the probability of losses increases, banks recognize additional provisioning expenses, which reduces net profit and return on equity.

The impact on net interest margin will also depend on funding costs, loan rates, and the composition of the loan portfolio. Higher reserves directly weigh primarily on bottom-line profit.

Tightening lending could slow the economy

In Chernov’s view, deterioration in debt quality could prompt banks to tighten borrower requirements. More expensive and less accessible credit would restrain business investment and consumer spending.

This raises the risk of an economic slowdown. The most vulnerable are companies that need to repay existing obligations through new borrowing: high financing costs complicate debt servicing and increase default risk.

Earlier, Freedom Broker noted that lower provisioning costs supported JPMorgan’s profit in Q1 2026. They totaled $2.51 billion and came in 17% below expectations. At the same time, a downward revision to the net interest income forecast restrained assessments of the bank’s outlook.

Lower provisioning expenses also became one of the factors behind strong quarterly results for Bank of America. Now the rise in distressed debt creates the risk of the opposite dynamic: increasing reserves could weaken support for banks’ profits.

Not an individual investment recommendation.