Major banks are gearing up for potential risks in their lending practices as interest rates soar to levels not seen in over 20 years and inflation continues to put pressure on consumers.
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 set aside to cover possible losses from credit risks, including overdue debts and problematic loans, such as commercial real estate loans.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter; Bank of America added $1.5 billion; Citigroup’s total allowance for credit losses reached $21.8 billion, marking a significant increase from the previous quarter; and Wells Fargo set aside $1.24 billion.
These accumulated reserves indicate that banks are bracing for a more challenging lending landscape, where both secured and unsecured loans may incur greater losses. A recent report from the New York Federal Reserve revealed that Americans collectively owe approximately $17.7 trillion in consumer, student, and mortgage loans.
Furthermore, the issuance of credit cards is rising, along with delinquency rates, as individuals tap into their pandemic-era savings and increasingly rely on credit. In the first quarter of this year, credit card balances hit $1.02 trillion, marking the second consecutive quarter where total balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector is also facing significant challenges.
“We’re still emerging from the COVID era, and concerning banking and consumer health, much of it stemmed from the stimulus provided to consumers,” noted Brian Mulberry, a portfolio manager at Zacks Investment Management.
However, potential issues for banks are anticipated in the coming months.
“The provisions in any given quarter don’t necessarily reflect the credit quality observed over the last three months; they indicate what banks project will happen in the future,” stated Mark Narron from Fitch Ratings.
Narron added that there has been a shift from relying solely on loan performance to a model driven by macroeconomic forecasts for determining provisions.
Currently, banks expect slower economic growth, higher unemployment rates, and two interest rate cuts anticipated in September and December, which could lead to an increase in delinquencies and defaults as the year concludes.
Citi’s CFO Mark Mason pointed out that emerging issues seem to be concentrated among lower-income consumers who have experienced a significant decrease in savings since the pandemic.
“While we see an overall resilient U.S. consumer, there’s a noticeable divergence in performance across different income bands and credit scores,” Mason said during a conference call with analysts.
He explained that only the highest income quartile has retained more savings since early 2019, and customers with FICO scores above 740 are driving spending growth. Conversely, those with lower credit scores are borrowing more and facing larger declines in payment rates, making them more vulnerable to the effects of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, waiting for inflation to stabilize around its target of 2% before implementing anticipated rate cuts.
Despite preparations for increased defaults later in the year, experts like Mulberry observe that defaults have not yet reached levels indicative of a consumer crisis. He is particularly monitoring the distinction between homeowners and renters during the pandemic era.
“While interest rates have increased significantly, homeowners locked in low fixed rates and aren’t feeling the same pressure,” Mulberry explained. “Renters, however, are struggling with rent rising over 30% nationally between 2019 and 2023, coupled with grocery costs increasing by 25% during the same period.”
For the time being, analysts noted that the latest earnings reports did not provide alarming news regarding asset quality. Strong revenues, profits, and stable net interest income indicate a robust banking sector.
“There is a resilience within the banking sector that came as no surprise, but it is reassuring to see that the structure of the financial system remains strong and stable right now,” Mulberry stated. “However, the longer interest rates remain elevated, the more stress they may inflict.”