As interest rates reach levels not seen in over 20 years and inflation continues to affect 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 raised their provisions for credit losses from the previous quarter. These provisions represent the funds banks allocate to cover potential losses from credit risks, including bad debt and delinquent loans, particularly in commercial real estate.
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, significantly increasing from the previous quarter, and Wells Fargo’s provisions were $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans may lead to greater losses among some of the largest banks in the country. A report from the New York Fed noted that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
There has been a rise in credit card issuance and delinquency rates as consumers find themselves relying more on credit as their pandemic savings diminish. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter where the total exceeded one trillion dollars, according to TransUnion. The commercial real estate sector is also facing significant challenges.
Brian Mulberry, a portfolio manager at Zacks Investment Management, commented, “We’re still emerging from the COVID period, which was significantly influenced by the consumer stimulus efforts.”
However, challenges for banks may arise in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported by banks reflect future expectations rather than past credit quality. He noted a shift from a historical approach where loan deterioration would trigger an increase in provisions, to a model where macroeconomic forecasts guide provisioning decisions.
Banks are currently forecasting slower economic growth, an increase in unemployment, and a couple of interest rate cuts expected later this year in September and December, which could lead to more delinquencies and defaults as the year concludes.
Mark Mason, Citigroup’s CFO, pointed out that early warning signs are particularly evident among lower-income consumers, who have seen their savings significantly decline since the pandemic.
Mason stated, “While the overall U.S. consumer remains resilient, we observe marked differences in financial performance and behaviors across income levels and credit scores.” He highlighted that only the highest income quartile has maintained more savings than they had at the start of 2019, with the highest credit score customers driving spending growth and high payment rates. Conversely, customers with lower credit scores are experiencing declines in payment rates and are increasing their borrowing primarily due to the pressures of high inflation and interest rates.
The Federal Reserve has kept interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation towards the bank’s target of 2% before implementing anticipated rate cuts.
Despite banks preparing for potentially higher defaults in the latter half of the year, Mulberry noted that defaults have yet to surge to a level indicating a consumer crisis. He is particularly interested in the distinction between homeowners and renters during the pandemic.
He added, “Homeowners secured low fixed-rate loans and aren’t feeling the immediate pinch, while renters, who couldn’t benefit from that opportunity, are facing increased rental costs.”
Since 2019, national rent prices have surged over 30%, with grocery costs also rising 25%. Renters are feeling the squeeze as rental prices have outpaced wage growth, creating financial pressure.
Currently, the latest earnings reports suggest that “there was nothing surprising this quarter concerning asset quality,” as strong revenues and profits indicate a healthy banking sector.
Narron concluded, “The banking sector shows resilience, and it’s reassuring to see that the foundations of the financial system remain strong.” However, he cautioned that prolonged high-interest rates could introduce more stress.