With interest rates reaching their highest levels in over 20 years and inflation putting pressure on consumers, major banks are bracing for potential risks related to their lending activities.
In the second quarter of this year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their reserves for credit losses compared to the previous quarter. These reserves represent the funds set aside by financial institutions to safeguard against possible losses due to credit risks, including defaults and delinquent loans, particularly in commercial real estate.
JPMorgan recorded a $3.05 billion increase in credit loss provisions for the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s total allowance for credit losses hit $21.8 billion by the end of the quarter, more than three times its previous quarter’s reserve build. Wells Fargo reported provisions of $1.24 billion.
These increased reserves reflect banks preparing for a more risky financial climate, where losses on both secured and unsecured loans may rise. The New York Federal Reserve’s recent analysis revealed that American households carry a collective debt of $17.7 trillion in various forms of loans, including consumer, student, and mortgage debts.
There has also been a rise in credit card issuance and delinquency rates as individuals deplete their savings from the pandemic and increasingly depend on credit. In the first quarter of this year, credit card balances surged to $1.02 trillion, marking the second consecutive quarter that total balances surpassed the trillion-dollar mark, according to TransUnion. Meanwhile, the commercial real estate sector remains vulnerable.
“We’re still emerging from the COVID era, particularly in banking and consumer health, which were supported by the stimulus provided to consumers,” commented Brian Mulberry, a portfolio manager at Zacks Investment Management.
Challenges for these banks are expected to become more pronounced in the coming months. “The provisions seen in any quarter do not necessarily reflect past credit quality but rather banks’ expectations of future developments,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
He added that the focus has shifted from a system where deteriorating loans would naturally increase provisions, to one where macroeconomic forecasts dictate provisioning levels.
In the short term, banks are anticipating slower economic growth, a rise in unemployment, and potential interest rate cuts in September and December. This may lead to higher delinquency and default rates as the year progresses.
Citi’s CFO, Mark Mason, pointed out that many of the warning signs are primarily affecting lower-income consumers, who have seen their savings significantly depleted since the pandemic. “While we see a generally resilient U.S. consumer, there is a noticeable disparity in performance based on credit scores and income levels,” he said during a conference call with analysts.
Mason noted that only the highest income quartile has managed to increase their savings since early 2019, with consumers holding high FICO scores driving spending growth and maintaining strong payment rates. In contrast, those with lower credit scores are facing decreased payment rates and increased borrowing, adversely affected by high inflation and interest rates.
The Federal Reserve has maintained interest rates at a two-decade high of 5.25-5.5%, awaiting stabilization in inflation toward its 2% target before considering the anticipated rate cuts.
Although banks are preparing for an uptick in defaults in the latter half of the year, current trends do not yet suggest a significant consumer crisis, according to Mulberry. He is particularly monitoring the differences between homeowners and renters from the pandemic era. “Yes, rates have risen significantly, but homeowners locked in low fixed rates on their debts, so they are not feeling the same financial strain,” he said. “Renters, however, who missed out on this opportunity, are facing challenges.”
Since 2019, rents have increased by over 30% nationwide, while grocery prices have gone up by 25%. Renters unable to secure low rates are experiencing the most financial pressure due to rising rental prices that have outpaced wage growth.
For now, the overall message from the latest earnings reports is that there are no significant new issues regarding asset quality noted. Strong revenues, profits, and a resilient net interest income signal that the banking sector remains healthy.
“There is some strength in the banking sector that may not have been entirely unexpected, but it is reassuring to see that the financial system’s foundations are still robust and sound at this point,” Mulberry remarked. “However, we are monitoring the situation closely, as sustained high-interest rates will inevitably lead to increased stress.”