With interest rates reaching the highest levels in over 20 years and inflation continuously affecting consumers, major banks are preparing for increased risks associated with their lending activities.
In the second quarter, prominent financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions represent funds that banks allocate to mitigate potential losses from credit risk, including defaults and poorly performing loans, such as 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 at the end of the quarter, marking more than a tripling of its reserve from the previous period. Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves indicate that banks are bracing themselves for a more uncertain lending environment, where both secured and unsecured loans could result in larger financial losses. A recent report from the New York Federal Reserve noted that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, the issuance of credit cards and the accompanying delinquency rates are on the rise as households deplete their pandemic-era savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, the second consecutive quarter that such balances have exceeded a trillion dollars, according to TransUnion. The CRE sector is also facing significant challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the ongoing transition from the pandemic era, highlighting the impact of government stimulus on consumer health.
However, banks anticipate that any difficulties will emerge in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that the provisions reported each quarter do not necessarily reflect the immediate credit quality but rather the banks’ expectations for future developments.
He added that the industry has shifted from a model where increasing loan defaults would drive up provisions, to one where macroeconomic forecasts dictate provisioning strategies.
In the short term, banks project a slowdown in economic growth, an increase in unemployment rates, and two anticipated interest rate cuts later this year. These conditions may result in higher delinquency and default rates as the year progresses.
Citi’s chief financial officer, Mark Mason, pointed out that the emerging financial concerns are primarily affecting lower-income consumers, who have seen their savings diminish post-pandemic.
“While we continue to observe resilient behavior among U.S. consumers overall, we’re noticing significant variations in performance across different income levels and credit scores,” Mason said during a recent analysts’ call. “Only the top income quartile has more savings now compared to early 2019, and it is the high-credit-score customers driving spending growth while maintaining strong payment rates. Customers with lower credit scores are experiencing reduced payment rates and increasingly relying on credit due to high inflation and interest rates.”
The Federal Reserve has maintained interest rates between 5.25% and 5.5%, the highest in 23 years, as it awaits stabilization in inflation toward the central bank’s 2% target before implementing anticipated rate cuts.
Despite banks expecting increased defaults in the latter part of the year, current trends do not indicate a consumer crisis just yet, according to Mulberry. He is particularly focused on the distinction between homeowners and renters during the pandemic period.
“Yes, interest rates have risen significantly since that time, but homeowners secured low fixed rates on their debt and are not experiencing substantial financial strain,” Mulberry explained. “In contrast, renters who missed the opportunity to lock in those lower rates are now facing challenges.”
Over the past four years, nationwide rents have surged over 30%, and grocery costs have risen by 25%. Renters unable to secure affordable rates are struggling to keep their budgets in check.
Presently, the key takeaway from the latest earnings reports is that there were no new concerns regarding asset quality. In fact, strong revenues, profits, and steady net interest income are positive signs for an otherwise healthy banking sector.
“There is some resilience within the banking system that was not entirely unexpected, but it’s reassuring to acknowledge that the financial structures remain robust and sound at this juncture,” Mulberry stated. “However, we are monitoring the situation closely, as prolonged periods of high interest rates could lead to increased stress.”