As interest rates reach levels not seen in over two decades and inflation continues to affect consumers, major banks are preparing for increased risks associated with their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions are funds that financial institutions set aside to cover potential losses from credit risks, including debts that are delinquent or considered bad, as well as commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in 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, marking a threefold increase from its previous reserve. Wells Fargo’s provisions amounted to $1.24 billion.
The increased reserves indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans could lead to substantial losses. A recent analysis of household debt by the New York Fed revealed that Americans owe a total of $17.7 trillion across consumer loans, student loans, and mortgages.
Additionally, credit card issuance is on the rise, accompanied by increasing delinquency rates as individuals tap into their pandemic-era savings. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total balances surpassed the trillion-dollar mark, according to TransUnion. The commercial real estate sector remains in a particularly vulnerable position.
According to Brian Mulberry, a portfolio manager at Zacks Investment Management, the banking sector is still recovering from the COVID era, largely due to the stimulus measures directed at consumers.
Experts suggest that challenges for banks may intensify in the upcoming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions reflect banks’ expectations about future credit quality rather than historical performance.
In the near future, banks foresee a slowdown in economic growth, an increase in the unemployment rate, and two anticipated interest rate cuts in September and December, which could result in more delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, pointed out that the areas of concern seem to be concentrated among lower-income consumers, who have experienced a decline in savings post-pandemic.
Mason noted, “While we continue to see an overall resilient U.S. consumer, we also continue to see a divergence in performance and behavior across income brackets.” He added that only the highest income quartile has maintained more savings than at the start of 2019, with customers scoring over 740 on FICO driving spending growth and keeping high payment rates. Conversely, those in lower FICO categories are facing declining payment rates and increasing debt burdens due to the impacts of inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it awaits stabilization of inflation towards the central bank’s target of 2% before implementing expected rate cuts.
Despite preparations for broader defaults later in the year, Mulberry stated that current default rates do not indicate an impending consumer crisis. He highlighted a contrast between homeowners and renters during the pandemic. Homeowners locked in low fixed rates and are less affected by rising costs, while renters, who did not benefit from these low rates, are facing increased financial strain.
With rents surging over 30% and grocery prices rising by 25% nationally from 2019 to 2023, renters are experiencing greater stress on their budgets compared to homeowners.
Overall, the most significant insight from the latest earnings reports is that there were no new developments regarding asset quality. Strong revenue, profits, and solid net interest income suggest that the banking sector remains healthy. Mulberry remarked, “There’s some strength in the banking sector that I don’t know was totally unexpected, but it’s certainly a relief to see that the financial system structures are still very strong and sound at this time.” However, the ongoing high interest rates are a cause for concern.