As interest rates remain at the highest levels seen in over two decades and inflation continues to impact consumers, major banks are preparing for increased risks associated with their lending practices.
In the second quarter, leading banks, including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo, increased their provisions for credit losses compared to the previous quarter. These provisions represent funds set aside to cover potential losses from credit risks, such as delinquent debts and loans, including commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s credit loss allowance reached $21.8 billion by the end of the quarter, reflecting a significant increase from the previous quarter, and Wells Fargo provisioned $1.24 billion.
These provisions indicate that banks are bracing for a potentially riskier lending environment, where both secured and unsecured loans may lead to larger losses. A recent analysis from the New York Federal Reserve revealed that Americans are collectively indebted to the tune of $17.7 trillion in consumer loans, student loans, and mortgages.
The rise in credit card usage and delinquency rates has also been noted as individuals begin to exhaust their pandemic savings and increasingly rely on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter where total cardholder balances exceeded the trillion-dollar milestone, according to TransUnion. The CRE sector remains particularly vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the impact of COVID-19 and subsequent stimulus measures play a significant role in the current economic landscape for consumers and banks.
However, any difficulties for banks are anticipated to manifest in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that quarterly provisions do not necessarily reflect recent credit quality but rather banks’ expectations for the future.
Banks are currently forecasting a slowdown in economic growth, an increase in unemployment rates, and two interest rate cuts expected later in the year. This scenario could lead to more delinquencies and defaults as the year concludes.
Citigroup’s chief financial officer, Mark Mason, highlighted that the emerging challenges seem concentrated among lower-income consumers, who have seen their savings deplete following the pandemic.
“While the overall U.S. consumer remains resilient, there is a noticeable divergence in performance based on income and credit scores,” Mason stated during a recent analyst call, noting that only the top income quartile has more savings than in early 2019. Those in lower credit score brackets are experiencing sharper declines in payment rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% while monitoring inflation trends relative to its 2% target before implementing any rate cuts.
Despite banks bracing for potential defaults in the upcoming months, current default rates do not indicate an imminent consumer crisis, according to Mulberry. He pointed out that homeowners who secured low fixed rates during the pandemic are less affected by rising interest rates compared to renters, who have faced significant rent increases amid stagnant wage growth.
Rent prices have surged by over 30% across the nation from 2019 to 2023, while grocery costs have increased by 25%. Renters, lacking the same opportunities as homeowners, are feeling the financial strain more acutely.
For now, the key takeaway from the latest earnings reports is that there were no significant new concerns regarding asset quality in the banking sector. Strong revenues, profits, and net interest income are encouraging signs of ongoing stability.
“There’s a sense of strength in the banking sector that was somewhat reassuring; it confirms the financial system remains robust,” Mulberry remarked, though he cautioned that prolonged high-interest rates could generate more stress over time.