As interest rates remain at their highest in over two decades and inflation continues to pressure consumers, major banks are gearing up for potential challenges stemming from their lending strategies.
In the second quarter, major financial institutions such as 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 to cover anticipated losses from credit risks, which include delinquent debts and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter, while Bank of America set aside $1.5 billion. Citigroup reported total allowances for credit losses of $21.8 billion at the end of the quarter, more than tripling its reserve from the previous quarter. Wells Fargo established provisions totaling $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier lending environment that could lead to larger losses on both secured and unsecured loans. A recent analysis by the New York Federal Reserve highlighted that total household debt in the U.S. has reached $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
There is also a rising trend in credit card issuance and delinquency rates, as consumers begin to deplete their pandemic-era savings and increasingly turn to credit. According to TransUnion, credit card balances achieved $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total balances surpassed the trillion-dollar threshold. Additionally, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking landscape is still feeling the effects of the COVID-19 pandemic, particularly regarding consumer health which was bolstered by government stimulus.
However, potential issues for banks may become more pronounced in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions reflect banks’ expectations of future credit quality rather than just recent trends.
Banks forecast a slowdown in economic growth, a rise in unemployment, and anticipate possible interest rate cuts later this year. This may lead to increasing delinquency rates and defaults as the year concludes.
Citigroup CFO Mark Mason observed that many of the warning signs are particularly evident among lower-income consumers, who have seen their savings diminish since the pandemic.
While there remains an overall resilience in the U.S. consumer market, a discordance in spending behaviors has emerged. The highest income bracket has maintained or increased savings since early 2019, while lower-income segments are experiencing declining payment rates and are borrowing more due to the effects of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation towards a target of 2% before implementing expected rate cuts.
Despite banks bracing for higher default rates in the latter half of the year, current default levels do not indicate a major consumer crisis, according to Mulberry. He noted a significant divide between homeowners, who have locked in low fixed mortgage rates, and renters, who are facing rapidly increasing rental costs without the benefit of those low rates.
With rental prices rising over 30% from 2019 to 2023 and grocery costs up 25% in the same timeframe, renters who have not secured low rates are facing significant financial strain, as noted by Mulberry.
Overall, the recent earnings reports from banks indicated no new concerning trends regarding asset quality. Strong revenues, profits, and consistent net interest income signal a stable banking sector for the time being. Mulberry expressed relief that the financial system remains robust, although ongoing high interest rates could lead to increased stress in the future.