With interest rates at their highest in over 20 years and inflation pressing down on consumers, major banks are gearing up to confront more risks associated with their lending strategies.
In the second quarter, prominent financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions represent funds set aside by banks to account for possible losses from credit risks, which can include delinquent debt and various types of loans, including commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance surged to $21.8 billion, more than tripling its previous quarter’s reserves, and Wells Fargo designated $1.24 billion for this purpose.
The increase in these provisions indicates that banks are preparing for a potentially riskier lending environment, where both secured and unsecured loans might lead to greater losses. A recent analysis from the New York Fed revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, there has been a rise in credit card issuance and associated delinquency rates as consumers deplete their savings accumulated during the pandemic and increasingly depend on credit. TransUnion reported that total credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that cardholder balances surpassed this threshold. The commercial real estate sector continues to remain precarious.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted the lingering impacts of the COVID era on consumer finance, particularly highlighting the role of government stimulus.
Looking ahead, banks face potential challenges in the near future. Mark Narron, a senior director at Fitch Ratings, explained that current provisions do not necessarily reflect the credit quality observed in the last quarter but rather what banks anticipate for the future.
Banks are forecasting a slowdown in economic growth, an uptick in unemployment, and potential interest rate cuts later this year. This scenario may lead to increased delinquencies and defaults as the year closes.
Citi’s chief financial officer, Mark Mason, pointed out that these emerging issues are particularly pronounced among lower-income consumers, whose savings have diminished since the pandemic began.
He observed that only the highest-income quartile has more savings than they did at the start of 2019, with consumers possessing credit scores above 740 contributing to spending growth and maintaining payment rates. In contrast, those in lower credit score brackets are experiencing more significant drops in payment rates and are reliant on credit amid rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year peak of 5.25-5.5%, holding off on cuts until inflation stabilizes towards the target rate of 2%.
Despite banks preparing for increased defaults in the latter part of the year, Mulberry noted that defaults have not yet escalated to a level indicative of a consumer crisis. He is particularly observing the distinction between homeowners and renters from the pandemic’s duration.
He indicated that while interest rates have climbed significantly, homeowners who secured low fixed rates on their debt are not feeling as much financial strain as those renting, who have seen rents surge by over 30% nationwide from 2019 to 2023, while grocery prices rose by 25%.
Currently, according to Narron, the key observation from the latest earnings reports is that there are no significant new concerns regarding asset quality. Strong revenues, profits, and solid net interest income are reflective of a robust banking sector.
Mulberry acknowledged some resilience within the banking system, describing it as a relief to confirm that the financial framework remains stable despite high interest rates, though he noted that prolonged elevated rates could lead to increased stress on consumers and financial institutions.