As interest rates remain at their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for increased risks associated with their lending strategies.
In the most recent quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions represent funds set aside by financial institutions to mitigate potential losses related to credit risks, including bad debt and loans, particularly in the commercial real estate (CRE) sector.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, more than tripling its previous credit reserve buildup, and Wells Fargo had provisions totaling $1.24 billion.
These heightened reserves indicate that banks are preparing for a challenging lending environment, where both secured and unsecured loans could lead to greater losses. A recent study by the New York Federal Reserve revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Furthermore, credit card issuance and delinquency rates are increasing due to dwindling pandemic-era savings and rising reliance on credit. Credit card balances hit $1.02 trillion in the first quarter, marking the second consecutive quarter that totals surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector is also facing uncertainty.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, highlighted that the banking sector’s health is still influenced by the stimulus measures implemented during the pandemic.
However, the concerning trends for banks may become more pronounced in the upcoming months. According to Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, the provisions announced in any given quarter do not necessarily reflect credit quality for that period but are based on banks’ future expectations.
He observed a shift in the banking sector’s approach to provisioning, which is now driven more by macroeconomic forecasts rather than reactive measures to defaulting loans.
Looking ahead, banks anticipate slower economic growth, increased unemployment, and two expected interest rate cuts later this year in September and December, which could lead to more delinquencies and defaults towards the end of the year.
Citi’s chief financial officer, Mark Mason, pointed out that the concerning trends are particularly evident among lower-income consumers, whose savings have diminished since the pandemic began.
While the overall U.S. consumer appears resilient, Mason noted significant performance disparities across income levels. Only the highest income quartile has managed to maintain or increase savings since 2019, with customers holding FICO scores above 740 driving spending growth and maintaining payment rates. In contrast, those with lower FICO scores are experiencing a decline in payment rates and increasing borrowing due to the impacts of inflation and high interest rates.
The Federal Reserve has kept interest rates steady at a 23-year high of 5.25-5.5% as it waits for inflation measures to stabilize near its 2% target before implementing anticipated rate cuts.
Despite banks preparing for a potential rise in defaults, Mulberry stated that current default rates do not indicate an impending consumer crisis. He highlighted a distinction between homeowners and renters during the pandemic, indicating that homeowners, benefiting from low fixed-rate mortgages, are largely insulated from immediate financial stress, while renters are facing significant strain due to rising rents and stagnant wage growth.
Currently, the latest earnings reports do not reveal any new concerns regarding asset quality, according to Narron. Positive indicators, including strong revenues and net interest income, suggest that the banking sector remains robust.
Mulberry noted that while there are signs of strength in the banking sector, prolonged high-interest rates may lead to increased stress over time.