As interest rates remain at their highest levels in over 20 years and inflation continues to pressure consumers, major banks are preparing for increased risks associated with their lending operations.
During the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions are funds that banks set aside to manage potential losses from credit risks, which include bad debt and delinquent loans, as well as commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, whereas Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses amounted to $21.8 billion by the end of the quarter, representing more than a tripling of its reserves from the previous quarter. Wells Fargo placed $1.24 billion into provisions.
These provisions signal that banks are bracing for a more challenging financial environment, where both secured and unsecured loans might result in larger losses. A recent analysis by the New York Federal Reserve highlighted that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
The rise in credit card issuance and delinquency rates is also concerning as consumers, having depleted their pandemic-era savings, increasingly rely on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also remains in a vulnerable state.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector’s health is closely tied to the effects of consumer stimulus during the COVID era.
However, experts suggest banks’ current difficulties may manifest in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported by banks don’t necessarily indicate credit quality over the past three months; rather, they reflect anticipated future challenges.
“The macroeconomic forecast heavily influences provisioning practices now, shifting from a historical model where increasing bad loans led to higher provisions,” Narron said. Banks expect slowing economic growth, a rise in unemployment, and two interest rate cuts later this year, likely signaling increased delinquencies and defaults as the year draws to a close.
Citigroup’s chief financial officer, Mark Mason, pointed out that emerging red flags are predominantly among lower-income consumers, whose savings have significantly decreased since the pandemic.
“While the overall U.S. consumer remains resilient, a notable divergence exists in performance based on income and credit score,” Mason stated during a recent call with analysts. “Only the highest income quartile has managed to retain more savings since early 2019, with higher FICO score customers driving spending growth and maintaining high payment rates. In contrast, those in lower FICO bands are experiencing greater declines in payment rates and increased borrowing, affected more severely by high inflation and interest rates.”
The Federal Reserve has maintained interest rates at a 23-year high between 5.25% and 5.5%, awaiting stabilization in inflation metrics towards the central bank’s target of 2% before implementing anticipated rate cuts.
Despite banks bracing for more defaults in the latter half of the year, current default rates do not indicate a widespread consumer crisis, according to Mulberry. He is observing the disparity between homeowners and renters during the pandemic, noting that while interest rates have risen, those who secured low fixed rates on their mortgages are not feeling comparable financial pressure.
In contrast, renters, who did not have the opportunity to lock in low rates during this period, are facing housing costs that have surged over 30% nationwide since 2019 and grocery costs that have increased 25%, leading to heightened stress on their budgets.
The latest earnings reports highlight that “there was nothing new this quarter in terms of asset quality,” according to Narron. In fact, positive indicators such as robust revenues, profits, and strong net interest income suggest that the banking sector remains financially healthy.
“There’s a level of strength in the banking sector that, while perhaps not entirely unexpected, is a reassuring sign. The foundational aspects of the financial system appear strong and sound at this time,” Mulberry remarked. “However, we must remain vigilant; the longer interest rates remain high, the more stress it could induce.”