With interest rates reaching their highest levels in over 20 years and inflation continuing to challenge consumers, major banks are gearing up to confront increased risks associated with their lending activities.
JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all reported higher provisions for credit losses in the second quarter compared to the previous quarter. These provisions are reserves set aside by financial institutions to cover potential losses from credit risks, including delinquent debts and loans tied to commercial real estate (CRE).
In the second quarter, JPMorgan increased its provision for credit losses to $3.05 billion, Bank of America set aside $1.5 billion, Citigroup’s allowance totaled $21.8 billion, more than tripling from the previous quarter, and Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging environment, as both secured and unsecured loans may result in larger losses. A recent analysis from the New York Fed revealed that American households collectively owe $17.7 trillion across various consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as consumers exhaust pandemic-era savings and rely more heavily on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also remains in a vulnerable position.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector is still navigating the aftermath of the pandemic, heavily influenced by the stimulus measures implemented for consumers.
The potential challenges for banks are anticipated in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that current provisions do not merely reflect recent credit quality but rather what banks expect to occur going forward.
Narron added that the system has shifted from reacting to bad loans to allowing macroeconomic forecasts to dictate provisioning levels. In the short term, banks foresee slowing economic growth, a rise in unemployment, and potential interest rate cuts later this year, which could lead to more delinquencies and defaults as the year progresses.
Citi’s chief financial officer Mark Mason indicated that warning signs are particularly evident among lower-income consumers, whose savings have dwindled since the pandemic began. Although the overall U.S. consumer remains resilient, Mason pointed out noticeable disparities based on income and credit scores.
He stated that only the top income quartile has more savings now compared to early 2019, with those holding over a 740 FICO score driving growth in spending and maintaining high payment rates. In contrast, lower FICO band customers are experiencing significant declines in payment rates and increasing borrowing due to the impact of high inflation and interest rates.
The Federal Reserve has maintained interest rates in the range of 5.25-5.5%, the highest in 23 years, as it awaits signs of inflation stabilizing toward its 2% target before implementing the anticipated rate cuts.
While banks brace for a potential rise in defaults later in the year, current trends do not indicate a consumer crisis, according to Mulberry. He is particularly keen on observing the conditions faced by homeowners versus renters during the pandemic, given that homeowners locked in favorable fixed rates while renters are now confronting rising costs without such advantages.
With rents increasing over 30% nationwide since 2019 and grocery costs climbing 25% during the same period, renters—who missed out on the low rate opportunities—are feeling the most pressure on their budgets.
For the moment, the latest round of earnings reports indicates that asset quality has remained stable, with strong revenues and profits suggesting a robust banking sector. Mulberry stated that while there is some unexpected strength within the banking sector, the prolonged high interest rates could introduce further stress in the future.