As interest rates remain at their highest levels in over two decades and inflation continues to affect consumers, major banks are bracing for increased risks stemming from their lending strategies.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo have all increased their provisions for credit losses compared to the previous quarter. Provisions are funds set aside by financial institutions to cover potential losses from credit risks, including bad debt and delinquent loans, notably in sectors like commercial real estate.
JPMorgan allocated $3.05 billion in provisions for credit losses during the second quarter; Bank of America set aside $1.5 billion; Citigroup’s allowance reached $21.8 billion, marking a tripling of its previous credit reserve; while Wells Fargo accounted for $1.24 billion.
These provisions indicate that banks are anticipating a more challenging lending environment, with both secured and unsecured loans posing a greater risk of losses. A recent report from the New York Federal Reserve revealed that American households currently owe a staggering $17.7 trillion in consumer, student, and mortgage loans.
Furthermore, the issuance of credit cards and delinquency rates are both climbing as consumers exhaust their pandemic-era savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, representing the second consecutive quarter where total cardholder balances surpassed the trillion-dollar mark, according to TransUnion. The commercial real estate sector remains particularly vulnerable.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking industry is still recovering from the COVID-19 pandemic, which was significantly supported by government stimulus measures.
However, any significant issues for banks are anticipated to arise in the coming months. Mark Narron, a senior director at Fitch Ratings, highlighted that the provisions reported quarterly reflect banks’ expectations for the future rather than past credit quality.
Currently, banks foresee a slowdown in economic growth, an increase in unemployment rates, and potential interest rate cuts in September and December. These factors could lead to higher delinquency rates and defaults as the year progresses.
Citigroup’s chief financial officer, Mark Mason, pointed out that the financial challenges appear to be particularly pronounced among lower-income consumers, whose savings have diminished since the pandemic.
Although the overall U.S. consumer remains resilient, there is a noticeable disparity in performance across different income and credit score categories. The highest income quartile is the only group currently holding more savings than in early 2019, and consumers with FICO scores above 740 are contributing to spending growth. In contrast, lower FICO band customers are experiencing a decline in payment rates and increasing reliance on borrowing, heavily affected by rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation around its 2% target before considering rate cuts.
Despite preparations for more potential defaults later in the year, current default rates do not yet suggest a consumer crisis, according to Mulberry. He noted that homeowners who locked in low fixed rates during the pandemic may not be feeling the financial strain as acutely as renters, who have missed out on those favorable conditions.
As rents have surged over 30% and grocery prices have risen by 25% from 2019 to 2023, renters without locked-in low rates are facing greater financial pressure.
The most recent earnings reports reveal no significant changes in asset quality. Strong revenues, profits, and net interest income are encouraging signs of a stable banking sector.
Mulberry expressed relief that the financial system remains strong, though he cautioned that prolonged high interest rates could introduce more stress to the sector.