As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for potential risks associated with their lending strategies.
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 represent the funds that financial institutions allocate to cover anticipated losses arising from credit risk, including delinquent or bad debts, as well as loans, particularly in commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America reported $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, more than tripling its reserve from the prior period, and Wells Fargo provided $1.24 billion.
These increased provisions indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans may lead to significant losses for some of the largest financial institutions in the country. A recent analysis by the New York Federal Reserve found that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards, along with rising delinquency rates, is becoming evident as consumers exhaust their pandemic-era savings and increasingly rely 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 mark, as reported by TransUnion. Additionally, the CRE sector is experiencing instability.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the effects of the COVID-19 pandemic are still being felt, particularly regarding consumer health and banking, largely due to the stimulus measures implemented during that time.
Banks are cautiously anticipating challenges in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that the provisions reported by banks do not merely reflect the credit quality of the past three months but also their expectations for future conditions.
He noted a shift in focus from traditional risk assessment methodologies, where increased bad loans would typically result in higher provisions, to a framework where macroeconomic forecasts significantly influence provisioning decisions.
Currently, banks foresee a slowdown in economic growth, a rise in the unemployment rate, and potential interest rate cuts later this year in September and December, which may lead to an increase in delinquencies and defaults by year-end.
Citi’s CFO Mark Mason highlighted that the indicators of financial strain appear most pronounced among lower-income consumers, who have seen their savings diminish in the aftermath of the pandemic. Data shows that only the highest income quartile has managed to increase their savings since early 2019, particularly among consumers with a FICO score above 740, who are driving spending growth and maintaining high payment rates. In contrast, borrowers with lower FICO scores are experiencing a decline in payment rates and are more affected by high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25% to 5.5%, awaiting stabilization in inflation measures towards its 2% target before implementing anticipated rate cuts.
Despite banks preparing for potential defaults in the latter half of the year, current data does not indicate a consumer crisis, according to Mulberry. He observes a noteworthy distinction between homeowners who secured low fixed rates during the pandemic and renters who missed that opportunity.
While interest rates have significantly increased since then, homeowners are not feeling the financial strain due to their advantageous mortgage terms. Conversely, renters, who have faced over a 30% rise in rents nationwide since 2019 and a 25% increase in grocery costs, are experiencing heightened pressure on their budgets.
Despite these concerns, analysts note no significant new developments regarding asset quality in the latest earnings reports. Strong revenues, profits, and a resilient net interest income point to the banking sector’s continued health.
Mulberry remarked on the overall strength of the financial system, emphasizing that while some positive indicators were anticipated, the enduring high-interest rates could introduce greater stress over time.