With interest rates reaching levels not seen in over two decades and inflation continuing to put pressure on consumers, major banks are bracing for potential challenges in their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside to cover potential losses from credit risks, which include bad debts and various types of loans, such as those in commercial real estate.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter, while Bank of America set aside $1.5 billion. Citigroup reported a total allowance for credit losses of $21.8 billion, marking a significant increase from the previous quarter, and Wells Fargo contributed $1.24 billion to its provisions.
These reserve increases indicate that banks are anticipating a more challenging environment, where both secured and unsecured loans may lead to larger losses for some of the nation’s top financial institutions. A recent analysis by the New York Fed showed that American households owe a collective $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards and delinquency rates are also rising as individuals deplete their savings accumulated during the pandemic and increasingly rely on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter that cardholder balances surpassed this threshold, according to TransUnion. Additionally, the commercial real estate market remains under significant pressure.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the ongoing effects of the COVID era, particularly boosted by consumer stimulus, are influencing banking stability.
Experts warn that any challenges for banks may manifest in the months ahead. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that provisions reported in any given quarter reflect banks’ expectations of future credit quality rather than past performance.
In the near term, banks are projecting slower economic growth and a rise in unemployment, along with potential interest rate cuts expected later this year. This may lead to increased delinquencies and defaults as the year progresses.
Citi’s Chief Financial Officer Mark Mason highlighted that concerning trends seem to be more pronounced among lower-income consumers, who have seen their savings decline since the pandemic.
“While we continue to see an overall resilient U.S. consumer, we also continue to see a divergence in performance and behavior across different income levels and credit scores,” Mason stated. He noted that only the highest income bracket appears to have improved savings since 2019, with those holding credit scores above 740 driving spending growth and maintaining high payment rates. In contrast, individuals in lower credit brackets are struggling more significantly due to high inflation and interest rates.
The Federal Reserve has maintained interest rates at a peak of 5.25-5.5% for 23 years, waiting for inflation indicators to stabilize toward its 2% target before considering any rate reductions.
Despite the banks gearing up for potential defaults later this year, current default rates do not indicate a consumer crisis, Mulberry pointed out. He emphasized the differences in experiences between homeowners and renters during the pandemic. Homeowners, who secured low fixed rates on their debt, may not feel the financial impact as acutely as renters, who face rising rental costs.
With rents increasing over 30% nationwide from 2019 to 2023 and grocery prices surging 25% in the same timeframe, renters are often more financially strained than homeowners, according to Mulberry.
For now, experts conclude that the latest earnings reports show no significant deterioration in asset quality. Strong revenues, profits, and net interest income signal a robust banking sector. Mulberry remarked on the existing strength within financial institutions, reassuring that the foundation of the financial system remains sound, although mounting stress could arise if interest rates persist at current high levels.