As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are preparing for increased risks associated with their lending practices.
In the second quarter of this year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions reflect the funds set aside to cover potential losses from credit risks, including bad debts and loans, particularly in the commercial real estate sector.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, more than tripling their reserve increase from the prior quarter. Wells Fargo reported provisions of $1.24 billion.
This increase in provisions suggests that banks are anticipating a more challenging environment, where both secured and unsecured loans may result in larger losses. A recent analysis from the New York Fed revealed that American households collectively owe $17.7 trillion across various types of loans, including consumer, student, and mortgage loans.
Moreover, credit card issuance and delinquency rates are rising as many individuals deplete their pandemic-era savings and turn to credit more frequently. According to TransUnion, total credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where the total surpassed the trillion-dollar mark. The commercial real estate sector also continues to face uncertainties.
Experts, like Brian Mulberry from Zacks Investment Management, underscore that the aftereffects of the COVID era are still present in the banking sector, largely due to previous stimulus measures aimed at consumers.
Problems for banks are expected to emerge in the following months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, pointed out that provisions reported by banks often reflect expectations for the future rather than a snapshot of recent credit quality.
Currently, banks anticipate a slowdown in economic growth, a higher unemployment rate, and potential interest rate cuts later this year, suggesting that delinquencies and defaults may increase towards the end of the year.
Citigroup’s chief financial officer, Mark Mason, highlighted that issues appear to be concentrated among lower-income consumers, who are facing diminishing savings since the pandemic.
Mason noted, “While we continue to see an overall resilient U.S. consumer, there is a noticeable divergence in performance based on income and credit score,” adding that only the highest income quartile has more savings than they did in early 2019. Customers with high credit scores are still driving spending and maintaining payment rates, whereas those with lower scores are experiencing a decline in payment rates and increasing debt loads due to rising inflation and interest rates.
The Federal Reserve has kept interest rates unchanged at a 23-year high of 5.25-5.5%, pending stabilization of inflation metrics towards the targeted 2% before implementing anticipated rate cuts.
Despite predictions of increased defaults later this year, Mulberry emphasized that default rates have not yet escalated to levels indicative of a consumer crisis. He is particularly attentive to the differences between homeowners and renters from the pandemic era.
While mortgage rates have risen substantially, many homeowners secured low fixed rates during that time, allowing them to avoid financial strain. Conversely, renters, lacking similar opportunities, have faced rental increases of over 30% nationwide since 2019, alongside a 25% rise in grocery costs. This has placed significant pressure on their budgets, especially in contrast to wage growth.
Despite the challenges, the most recent earnings reports indicate that there are no major concerns regarding asset quality at this time. Strong revenues, profits, and resilient net interest income suggest that the banking sector remains fundamentally healthy.
Narron remarked, “There’s no significant new concern regarding asset quality this quarter,” affirming that the financial system continues to exhibit strength. However, Mulberry cautioned that sustained high interest rates could lead to increased stress in the banking industry moving forward.