As interest rates remain at their highest levels in over 20 years and inflation continues to affect consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, prominent banks including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo elevated their provisions for credit losses compared to the previous quarter. These provisions reflect the amount set aside by financial institutions to cover potential losses arising from credit risks, such as bad debts and delinquencies in commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America reserved $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, significantly more than the previous quarter, and Wells Fargo set aside $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans might lead to bigger losses. A recent analysis from the New York Federal Reserve revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also increasing as consumers exhaust their pandemic-era savings and turn to credit more frequently. Credit card balances hit $1.02 trillion in the first quarter of 2023, marking the second consecutive quarter that totals have surpassed the trillion-dollar threshold. Additionally, commercial real estate remains in a vulnerable position.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, emphasized that the banking sector’s current health is largely influenced by the prior stimulus efforts aimed at consumers during the COVID-19 pandemic.
However, challenges for banks are anticipated in the coming months. Mark Narron, a senior director at Fitch Ratings, pointed out that the provisions reported by banks do not necessarily reflect credit quality over the last three months but are indicative of forecasts for future performance.
He noted a shift in the banking landscape, where macroeconomic projections increasingly dictate provisions rather than merely reacting to delinquent loans.
In the short term, banks are expecting slowing economic growth, a rise in unemployment rates, and predictions of two interest rate cuts later in the year. This scenario could lead to increased delinquencies and defaults as the year progresses.
Citi’s Chief Financial Officer Mark Mason highlighted that concerns are particularly apparent among lower-income consumers who have seen their financial cushions diminish since the pandemic. He mentioned that while the overall U.S. consumer remains resilient, stark disparities exist among different income levels.
Mason’s observations indicate that only the highest income quartile has managed to increase their savings since 2019, with those in the upper FICO score brackets driving spending and maintaining higher payment rates. Conversely, individuals with lower credit scores are experiencing sharp declines in payment rates amid rising inflation and interest rates.
The Federal Reserve has maintained interest rates between 5.25% and 5.5%, the highest in 23 years, awaiting stabilization in inflation rates targeted at 2% before implementing any expected rate cuts.
Despite banks’ preparations for potential defaults later in the year, defaults have not yet escalated to alarming levels that signal a consumer crisis. Mulberry is particularly focused on the divide between homeowners and renters during the pandemic. Homeowners had access to low fixed-rate mortgages, insulating them from immediate financial strain, while renters, facing a rental market that has surged over 30% since 2019, are feeling the pressure of increasing housing costs without the benefit of locked-in low rates.
With grocery prices also rising by 25% during this period, renters are confronting significant challenges within their monthly budgets.
Currently, the latest earnings reports reveal that there were no major surprises regarding asset quality. Strong revenues and profits, along with resilient net interest income, suggest that the banking sector remains fundamentally stable.
Mulberry concluded that the ongoing strength of the banking sector offers reassurance, although sustained high interest rates could eventually cause more strain moving forward.