With interest rates at their highest in over two decades and inflation continuing to impact consumers, major banks are bracing for potential risks associated with their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their provisions for credit losses compared to the previous quarter. These provisions are funds financial institutions set aside to address potential losses due to credit risk, including bad debts and lending, especially in commercial real estate.
JPMorgan set aside $3.05 billion for credit losses during the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, significantly increasing its reserves from the prior quarter, and Wells Fargo recorded provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a more uncertain environment where both secured and unsecured loans could lead to greater losses. According to a recent analysis of household debt by the New York Fed, Americans owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card usage and delinquency rates are rising as many consumers deplete their savings from the pandemic and turn to credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold. The commercial real estate sector also faces significant challenges.
Brian Mulberry, a portfolio manager at Zacks Investment Management, remarked on the transition from the COVID era, noting that consumer health was largely bolstered by previous stimulus measures.
However, any problems within the banks are expected to surface in the coming months.
Mark Narron, a senior director at Fitch Ratings, explained that current provisions do not reflect credit quality from recent months but rather banks’ expectations for future risks.
“As we see it, the current environment has shifted from a model where loan defaults lead to increased provisions to one driven by macroeconomic forecasts,” Narron noted.
Looking ahead, banks anticipate slower economic growth, rising unemployment, and possible interest rate cuts later this year, which could lead to higher delinquency and default rates by year-end.
Citi’s chief financial officer, Mark Mason, pointed out troubling trends primarily affecting lower-income consumers, who have seen their savings diminish since the pandemic.
“While the general U.S. consumer remains resilient, we observe varying performances across different income and credit score segments,” Mason stated. He highlighted that only the top income quartile has more savings than at the start of 2019, with higher FICO score customers leading in spending growth and payment reliability. In contrast, consumers in lower FICO bands are experiencing declines in payment rates and increasing borrowing, significantly impacted by high inflation and interest rates.
The Federal Reserve has maintained interest rates at 5.25-5.5%, the highest in 23 years, awaiting stabilization in inflation towards its 2% target before implementing anticipated rate cuts.
Although banks are preparing for an increase in defaults for the latter half of the year, current defaults are not rising at a level indicative of a consumer crisis, Mulberry concluded. He is closely monitoring the contrasting experiences of homeowners and renters from the pandemic era.
Despite rising rates, homeowners benefited from locking in low fixed rates on their debt, alleviating some of the financial strain. In contrast, renters, facing rent increases over 30% since 2019 and grocery prices up 25%, are under greater financial pressure as rental rates have outpaced wage growth.
Overall, the recent earnings reports suggest that there have been no significant changes in asset quality. The banking sector continues to show strong revenues, profits, and net interest income, indicating a robust financial system.
“There is some resilience in the banking sector that wasn’t completely unexpected, providing reassurance about the strength and stability of the financial system,” Mulberry remarked. However, he emphasized the need for vigilance as prolonged high-interest rates could lead to increasing stress.