As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks stemming from their lending activities.
In the second quarter, leading financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo boosted their provisions for credit losses compared to the previous quarter. These provisions are reserves set aside to manage potential losses from credit risk, including overdue payments and bad debts, particularly in areas like commercial real estate (CRE) lending.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America reported $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, more than tripling its previous reserve. Wells Fargo reported $1.24 billion in provisions.
These increases in reserves indicate that banks are preparing for a more hazardous lending environment, where both secured and unsecured loans might result in more significant losses. An analysis by the New York Fed revealed that American households owe a total of $17.7 trillion across various consumer loans, student loans, and mortgages.
Additionally, there is a rise in credit card usage and delinquency rates, as many consumers deplete their pandemic-era savings and increasingly turn to credit. According to TransUnion, credit card balances exceeded $1 trillion in the first quarter of this year for the second consecutive quarter. Furthermore, the commercial real estate sector remains in a fragile state.
Experts point out that the current economic climate is still influenced by the aftermath of the COVID-19 pandemic and the extensive stimulus measures that were implemented. Brian Mulberry, a client portfolio manager at Zacks Investment Management, highlighted that banks will likely face challenges in the coming months as the economic situation evolves.
Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported by banks reflect their expectations for future credit quality rather than past performance. He noted that the shift has been towards a forecasting model based on macroeconomic conditions.
In the short term, banks anticipate slower economic growth, rising unemployment, and two potential interest rate cuts later this year in September and December, which could lead to increased delinquencies and defaults as 2023 concludes.
Citigroup’s CFO Mark Mason indicated that the emerging challenges appear to be primarily affecting lower-income consumers who have seen their savings diminish since the pandemic. While overall consumer resilience remains, there is a notable divergence in behavior based on income levels and credit scores.
He pointed out that only the highest-income households have seen an increase in savings since early 2019. Those with strong credit scores are contributing to spending growth, while lower-income consumers are facing difficulties with rising inflation and interest rates, leading to decreased payment rates and increased borrowing.
As the Federal Reserve maintains interest rates at a 23-year high of 5.25-5.5%, waiting for inflation to stabilize, banks are acknowledging the potential for higher default rates later in the year. However, Mulberry notes that there are no immediate signs of a consumer crisis. He is particularly interested in examining the differences between homeowners and renters during this period of rising costs.
He explained that while interest rates have surged, homeowners locked in low fixed rates and are less affected. In contrast, renters, who did not have the same opportunity, are struggling with rent increases that have surged over 30% between 2019 and 2023, coupled with a 25% rise in grocery prices.
For the time being, the key takeaway from the most recent earnings reports is that there have been no significant changes in asset quality. Strong revenues, profitability, and net interest income indicate a robust banking sector. Mulberry concluded that the resilience within the financial system is reassuring, but the prolonged high interest rates are a factor to monitor closely as they could create further stress.