As interest rates reach their highest levels in over 20 years and inflation continues to pressure consumers, major banks are preparing for potential risks associated with their lending activities.
In the second quarter, leading financial institutions like 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 expected losses from credit risks, such as delinquent loans and issues related to commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, marking a tripling of reserves from the previous quarter, and Wells Fargo made provisions of $1.24 billion.
These increased reserves indicate that banks are bracing for a more challenging lending landscape that could lead to greater losses in both secured and unsecured loans. A recent report from the New York Fed highlighted that Americans collectively owe $17.7 trillion across various forms of credit, including consumer loans and mortgages.
Additionally, credit card issuance and delinquency rates are rising as consumers deplete their savings acquired during the pandemic and increasingly rely on credit. The total credit card balances hit $1.02 trillion in the first quarter, marking the second consecutive quarter that cardholder balances exceeded the trillion-dollar threshold. Commercial real estate (CRE) also remains in a vulnerable position.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that as the economy transitions out of the COVID-19 era, the effects of stimulus measures on consumer health remain significant.
However, banks are anticipating that any challenges will manifest in the coming months. Mark Narron, a senior director at Fitch Ratings, pointed out that current provisions do not solely reflect recent credit quality but also banks’ expectations about future conditions. He noted a shift in the banking industry, where macroeconomic forecasts are now a driving force behind provisioning, rather than solely a response to rising loan defaults.
In the short term, banks expect economic growth to slow, unemployment to rise, and possible interest rate cuts in September and December, which could lead to an increase in delinquencies and defaults towards the end of the year.
Citigroup’s CFO Mark Mason mentioned that the signs of financial strain appear to be most acute among lower-income consumers, who have seen their savings diminish since the pandemic. He emphasized a disparity in the financial health of consumers based on income levels, stating that only the top income quartile has more savings than pre-2019 levels, while lower FICO score customers are facing declining payment rates and are borrowing more aggressively under the pressure of 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 of inflation indicators toward the central bank’s 2% target before implementing anticipated rate cuts.
Despite banks preparing for increased defaults later this year, Mulberry indicated that current default rates do not signal an impending consumer crisis. He is particularly monitoring the situation of homeowners versus renters during this economic transition, noting that homeowners who secured low fixed rates during the pandemic are less affected by rising rates compared to renters who are struggling with escalating rental costs.
Between 2019 and 2023, rents surged over 30%, accompanied by a 25% increase in grocery prices, putting significant financial strain on renters who did not benefit from fixed-rate mortgages.
Overall, Narron pointed out that there were no major surprises regarding asset quality in the latest earnings reports. Strong revenues, profits, and stable net interest income reflect a currently robust banking sector. Mulberry expressed relief that the financial system’s structure remains strong, but he cautioned that prolonged high interest rates could increase stress in the system moving forward.