With interest rates reaching their highest levels in over two decades and inflation continuing to impact consumers, major banks are anticipating increased risks associated with their lending practices.
In 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 reserve to cover potential losses due to credit risk, encompassing delinquent loans and troubled lending sectors, such as commercial real estate.
JPMorgan set aside $3.05 billion for credit losses; Bank of America allocated $1.5 billion; Citigroup’s allowance rose to $21.8 billion, more than tripling from the previous quarter; and Wells Fargo reported provisions of $1.24 billion.
These reserve increases indicate that banks are preparing for a potentially riskier lending environment, where both secured and unsecured loans might lead to more substantial losses. An analysis by the New York Federal Reserve revealed that Americans collectively owe approximately $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, the issuance of credit cards is rising, along with delinquency rates, as individuals deplete their pandemic-era savings and increasingly depend on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances exceeded the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also remains in a precarious state.
Experts attribute part of the current banking situation to the residual effects of the COVID-19 pandemic and related stimulus measures. However, any potential difficulties for banks are expected to emerge in the forthcoming months.
“The provisions reported at any given quarter do not solely reflect credit quality from the last three months, but rather what banks anticipate will happen in the future,” said Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group. He noted a shift in the provisioning approach, moving from reacting to delinquent loans to forecasting based on macroeconomic conditions.
In the short term, banks foresee slower economic growth, increased unemployment, and possibly two interest rate cuts later this year, which could result in higher rates of delinquencies and defaults towards the end of 2023.
Citigroup’s Chief Financial Officer, Mark Mason, highlighted that indicators of financial strain are particularly pronounced among lower-income consumers, who have seen their savings decline since the pandemic.
“While overall, the U.S. consumer remains resilient, we notice significant differences in performance and behavior based on credit scores and income levels,” Mason stated during a recent analyst call. He pointed out that only the top income quartile has managed to save more compared to 2019, indicating that higher-income individuals are significantly contributing to spending growth and maintaining high payment rates. In contrast, lower-income consumers are struggling more with debts and are increasingly affected by soaring inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year peak of 5.25-5.5% while awaiting stabilization in inflation towards its 2% target before proceeding with anticipated rate cuts.
Despite banks bracing for a rise in defaults later this year, current default rates do not signal a looming consumer crisis, according to experts. Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted significant differences in the financial status of homeowners versus renters during the pandemic. Homeowners, who locked in low mortgage rates, are less affected by rising costs than renters, who are grappling with higher rents and increasing grocery prices.
For now, analysts are observing a stable banking sector, as recent earnings reports did not reveal any new issues related to asset quality. Positive indicators, including robust revenues and net interest income, suggest that the banking system remains healthy.
“There is strength in the banking sector that may not have been entirely unexpected, but it is reassuring to see that the financial system’s fundamentals are still sound at this moment,” Mulberry concluded. “Yet, we remain vigilant, as prolonged high-interest rates will inevitably lead to increased financial strain.”