As interest rates reach heights not seen in over 20 years and inflation continues to press on consumers, major banks are bracing for increased risks linked to 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 the funds that banks allocate to cover potential losses arising from credit risk, including defaults and bad debt, particularly in areas like commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance reached $21.8 billion, tripling its credit reserves from the prior quarter, and Wells Fargo’s provisions totaled $1.24 billion.
The increase in reserves signals that banks are preparing for a challenging economic landscape where both secured and unsecured loans may lead to greater losses. A recent analysis from the New York Federal Reserve indicated that American households carry a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as consumers deplete their pandemic savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total balances exceeded the trillion-dollar mark, as reported by TransUnion. The commercial real estate sector is also facing significant concerns.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked, “We’re still coming out of this COVID era, particularly concerning banking and consumer health, largely due to the stimulus measures that were introduced.”
However, challenges for the banks are expected in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, stated that banks’ provisions at any given time reflect their expectations for future credit quality rather than a direct indicator of recent performance.
“The transition has shifted from a historical model where bad loans prompted increased provisions to a model driven by macroeconomic forecasts,” he elaborated.
In the near future, banks anticipate slower economic growth, rising unemployment, and potential interest rate reductions later this year. These factors could lead to increased delinquency and defaults by year-end.
Citi’s chief financial officer, Mark Mason, pointed out that the warning signs are especially prevalent among lower-income consumers, who have seen their savings diminish since the pandemic began. “While the overall U.S. consumer remains resilient, we observe diverging trends across different income and credit score brackets,” Mason noted in a recent analyst call.
Analysis of consumer clients showed that only those in the highest income quartile have more savings now compared to early 2019, with higher FICO score customers driving spending growth. In contrast, those with lower credit scores are experiencing more significant declines in payment rates and are borrowing more due to the financial pressures of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year peak of 5.25-5.5%, awaiting stabilization in inflation metrics towards its 2% target before considering rate cuts.
Despite preparations for an uptick in defaults later this year, Mulberry indicated that defaults have not yet escalated to a level indicative of a consumer crisis. He is particularly monitoring the distinction between homeowners and renters during the pandemic.
“While interest rates have risen substantially, homeowners generally secured very low fixed rates on their debt, enabling them to avoid significant financial strain,” Mulberry explained. “In contrast, renters, who missed that opportunity, are currently facing the highest stress due to skyrocketing rental costs and grocery prices.”
For the time being, the consensus from the latest earnings reports suggests “no new concerns regarding asset quality.” Strong revenues, profits, and stable net interest income point to a resilient banking sector.
“There’s a degree of strength in the banking sector that wasn’t entirely unexpected, but it’s certainly reassuring to acknowledge that the foundations of the financial system remain solid at this moment,” said Mulberry. “However, as interest rates remain high, the potential for increased stress persists.”