As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks associated with their lending activities.
In the second 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 that banks set aside to mitigate potential losses from credit risks, including delinquent or bad debts, specifically in sectors like commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, significantly more than the amount it built in the previous quarter, and Wells Fargo’s provisions totaled $1.24 billion.
These reserves indicate that banks are preparing for a potentially riskier landscape, anticipating increased losses from both secured and unsecured loans. A report by the New York Fed highlighted that American households now owe a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are rising as pandemic savings diminish, leading consumers to rely more heavily on credit. As per TransUnion, total credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that balances exceeded a trillion dollars. Additionally, the commercial real estate sector remains in a challenging position.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, emphasized that the banking sector is still navigating the aftermath of the COVID-19 pandemic, particularly in relation to consumer health and the impact of previously distributed stimulus funds.
Experts suggest that emerging banking issues may manifest in the coming months. Mark Narron, a senior director at Fitch Ratings, pointed out that the current provisions reflect future expectations rather than past credit quality, acknowledging a shift in how banks manage their provisions based on macroeconomic forecasts.
In the near term, banks anticipate slowing economic growth, increased unemployment, and two interest rate cuts scheduled for September and December, which could lead to a rise in delinquencies and defaults as the year closes.
Citi’s chief financial officer Mark Mason indicated that the concerns appear to be primarily affecting lower-income consumers who have seen their savings deplete since the pandemic’s onset. He noted that only the highest income quartile has managed to increase their savings since early 2019, with those holding scores above 740 driving spending and maintaining prompt payment rates. In contrast, consumers in lower FICO brackets are experiencing declines in their payment rates as they struggle with high inflation and interest rates.
Currently, the Federal Reserve maintains interest rates at a 23-year high of 5.25-5.5%, awaiting signs of inflation stabilizing towards its 2% target before potentially enacting the anticipated rate cuts.
Despite banks preparing for increased defaults later in the year, Mulberry noted that defaults are not yet escalating at a rate indicative of a widespread consumer crisis. He observed that homeowners who locked in low fixed rates during the pandemic are largely insulated from the current monetary pressures, whereas renters, facing over 30% rental increases since 2019 and rising grocery costs, are feeling significant budget constraints.
Overall, analysts concluded that recent earnings reports revealed no major concerns regarding asset quality. Strong revenues, profits, and a resilient net interest income are reassuring signs for the banking sector’s health.
Mulberry highlighted that while the banking sector shows robust strength, which may not have been entirely unexpected, the sustained high-interest rates could lead to additional stress in the long run.