With interest rates reaching the highest levels in over two decades and inflation putting pressure on consumers, major banks are bracing for heightened risks associated with their lending activities.
In the second quarter, major 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 are sums set aside to mitigate potential losses from credit risks, including debts that may become delinquent or unrecoverable, particularly in areas like commercial real estate (CRE) lending.
JPMorgan allocated $3.05 billion for credit losses during 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, marking a three-fold increase from the previous quarter. Wells Fargo reported provisions amounting to $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging financial landscape, as both secured and unsecured loans could lead to greater losses. A recent report from the New York Fed highlighted that Americans collectively owe about $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card issuance is on the rise, with delinquency rates following suit, as consumers deplete their savings accumulated during the pandemic and increasingly depend on credit. The total credit card balances surpassed $1 trillion for the second consecutive quarter earlier this year, according to TransUnion. CRE also faces uncertain conditions.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the ongoing recovery from the COVID pandemic has been heavily influenced by the stimulus measures provided to consumers.
Looking ahead, potential issues for banks may arise in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions recorded in any given quarter do not necessarily reflect the credit quality for that time frame; instead, they represent banks’ expectations for future developments.
The banks anticipate that economic growth will slow, unemployment rates will increase, and interest rate cuts may occur later this year, which could lead to more delinquencies and defaults as the year concludes.
Citigroup’s chief financial officer, Mark Mason, indicated that concerns appear to be concentrated among lower-income consumers, who have seen significant reductions in their savings since the pandemic commenced.
While the overall U.S. consumer remains resilient, performance and behavior vary widely across different income levels and FICO score bands. Mason noted that only the highest income quartile has more savings now than at the start of 2019, and it is the customers with FICO scores above 740 who are driving spending growth and maintaining higher payment rates. Meanwhile, those in lower FICO bands are experiencing notable declines in payment rates and increased borrowing, as they are more adversely affected by inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it waits for inflation metrics to stabilize around the central bank’s target of 2% before implementing anticipated rate cuts.
Despite banks preparing for potential defaults later this year, current default rates do not indicate an imminent consumer crisis, according to Mulberry. He is particularly observing the distinction between homeowners and renters since the pandemic began.
While interest rates have increased significantly, homeowners have secured low fixed-rate debts, which means they are not feeling financial strain to the same extent as renters, who did not benefit from such conditions.
With rents increasing by more than 30% nationally from 2019 to 2023 and grocery prices rising by 25%, renters facing escalating expenses without corresponding wage growth are experiencing the most financial stress.
Currently, the key takeaway from the latest earnings reports is the stability of asset quality, according to Narron. Strong revenues, profits, and healthy net interest income support a resilient banking sector.
Mulberry emphasized that there are signs of strength within the banking system, indicating that financial structures remain solid. Nonetheless, monitoring is essential, as sustained high interest rates could lead to increased stress on consumers and the banking sector in the future.