As interest rates reach levels not seen in over two decades and inflation continues to impact consumers, major banks are bracing for potential risks associated with their lending practices.
In a recent report, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses during the second quarter compared to the previous quarter. These provisions represent the funds that banks set aside to account for possible losses due to credit risks, which include overdue debts and loans, particularly in the commercial real estate sector.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America reserved $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, more than tripling its reserve from the prior quarter, and Wells Fargo set aside $1.24 billion.
The increased reserves indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans may result in larger losses. A recent analysis by the New York Fed revealed that American consumers collectively owe $17.7 trillion in loans, including consumer debt, student loans, and mortgages.
Moreover, as pandemic-era savings diminish, the issuance of credit cards and the associated delinquency rates are rising. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total balances surpassed the trillion-dollar mark, according to TransUnion. The commercial real estate sector remains particularly vulnerable.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted that the economic landscape is still affected by the aftermath of the COVID-19 pandemic and the stimulus measures that were implemented during that period.
Experts indicate that any significant banking problems may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, emphasized that the provisions reported quarterly do not purely reflect recent credit quality, but rather, the banks’ expectations for the future.
Looking ahead, banks are forecasting slower economic growth, a rise in unemployment, and two anticipated interest rate cuts in September and December. This outlook could suggest more delinquencies and defaults as the year progresses.
Citigroup’s Chief Financial Officer Mark Mason highlighted that the challenges appear to be concentrated among lower-income consumers, who have seen their savings deplete since the pandemic.
While the overall U.S. consumer remains strong, there is a noticeable disparity in financial behavior across different income levels and credit ratings. Mason pointed out that only the highest income quartile has increased savings since early 2019, with those in the higher FICO score brackets driving spending growth and maintaining higher payment rates. In contrast, lower FICO score customers have been experiencing significant declines in their payment rates while increasing their borrowing, as they struggle more with high inflation and interest rates.
The Federal Reserve has maintained interest rates at a record high of 5.25-5.5% as it waits for inflation to stabilize near its 2% target before implementing expected rate cuts.
Despite banks preparing for an uptick in defaults later this year, Mulberry suggested that the current default rates do not yet indicate a consumer crisis. He pointed out the stark difference between homeowners, who benefited from locking in low fixed-rate mortgages during the pandemic, and renters, who have not had the same advantages.
With rental costs rising over 30% nationally from 2019 to 2023 and grocery prices increasing by 25% in that timeframe, renters who have not secured low rates are facing heightened financial pressure, according to Mulberry.
For the time being, the key takeaway from the latest earnings reports is that there are no significant concerns regarding asset quality. Strong revenues, profits, and healthy net interest income continue to reflect a solid banking sector.
Mulberry remarked on the resilience of the banking system, stating that while the current strength is reassuring, the ongoing high-interest rates could lead to increased stress for the financial system in the future.