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 in their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all augmented their provisions for credit losses compared to the previous quarter. These provisions represent funds set aside by banks to cover potential losses from credit risk, including delinquencies or bad debt, as well as lending activities like commercial real estate (CRE) loans.
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 its reserve build from the previous quarter, and Wells Fargo announced provisions totaling $1.24 billion.
These increased provisions reflect banks’ anticipation of a challenging economic environment where both secured and unsecured loans could lead to more significant losses. A recent New York Fed analysis revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
There has also been a surge in credit card issuance and delinquency rates as many individuals exhaust their savings accumulated during the pandemic and increasingly depend on credit. Credit card balances amounted to $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total balances surpassed the trillion-dollar mark, as per TransUnion. Furthermore, the CRE sector remains in a delicate situation.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the ongoing impact of COVID-19, combined with prior stimulus measures aimed at assisting consumers, continues to shape the banking landscape.
However, experts indicate that any issues banks may face are likely to manifest in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that quarterly provisions often reflect banks’ forecasts rather than recent credit quality.
As banks look ahead, they anticipate slowing economic growth, rising unemployment rates, and two potential interest rate cuts due later this year, potentially leading to increased delinquencies and defaults as the year concludes.
Citi’s CFO Mark Mason pointed out that the emerging concerns seem to be affecting lower-income consumers, who have experienced a decline in savings since the pandemic. He remarked on the disparity within consumer segments, indicating that only the highest income quartile has managed to save more than before 2019. Customers with credit scores above 740 are driving spending growth and maintaining high payment rates, in contrast to those in lower credit score brackets, who are struggling more with inflation and interest rates.
The Federal Reserve is maintaining interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation measures toward the central bank’s 2% target before executing anticipated rate cuts.
Despite preparations for increased defaults in the latter half of the year, Mulberry suggests that defaults have not yet reached levels indicative of a consumer crisis. He is particularly interested in the differences between homeowners and renters during the pandemic era.
While interest rates have significantly increased, Mulberry explains that homeowners have largely secured low fixed rates on their debt, allowing them to avoid financial strain. In contrast, renters, who missed that opportunity, are feeling the pinch as rents surged over 30% nationwide from 2019 to 2023 and grocery costs rose by 25% in the same period. This discrepancy is creating budgetary pressures, particularly for those whose wage growth has not kept pace with rising rent.
Overall, the latest earnings reports have shown no significant changes in asset quality, as noted by Narron. Strong revenues and profits, alongside robust net interest income, suggest that the banking sector remains healthy.
Mulberry commented that while the banking system still shows strength, ongoing high interest rates continue to exert stress. Observations and cautious vigilance will be essential as the economic landscape evolves.