Amidst interest rates that have reached over two-decade highs and persistent inflation affecting consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter of this year, financial giants such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their provisions for credit losses compared to the previous quarter. These provisions represent reserves set aside to cover potential losses due to credit risks, including defaults on loans and issues related to commercial real estate.
JPMorgan recorded a provision for credit losses amounting to $3.05 billion in the second quarter, while Bank of America reported $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, more than tripling its buildup compared to the previous quarter, and Wells Fargo set aside $1.24 billion.
This increase in reserves signals that banks are preparing for a more uncertain environment, where both secured and unsecured loans may lead to significant losses. According to a recent analysis by the New York Fed, Americans currently hold a staggering $17.7 trillion in consumer, student, and mortgage loans.
Meanwhile, credit card issuance is on the rise, with accompanying delinquency rates increasing as consumers exhaust their pandemic-related savings and turn more to credit. In the first quarter, overall credit card balances surged to $1.02 trillion, marking the second consecutive quarter in which total cardholder balances exceeded the trillion-dollar threshold, as reported by TransUnion. Concerns also persist about the state of commercial real estate.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, highlighted that the banking sector is still recovering from the COVID-19 pandemic, heavily influenced by the stimulus measures previously distributed to consumers.
Experts suggest that any challenges for banks are likely to manifest in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions seen in any given quarter do not necessarily reflect past credit quality but rather banks’ expectations for the future.
He pointed out a significant shift in the way provisions are determined, moving from a system reactive to rising loan defaults to one driven by forecasts of macroeconomic conditions. Currently, banks are anticipating slowed economic growth, rising unemployment, and potential interest rate cuts later this year, which could lead to increased delinquencies and defaults.
Mark Mason, Citi’s CFO, noted that signs of financial strain appear most pronounced among lower-income consumers, who have experienced a depletion of savings since the pandemic began. He stated that only the highest-income quartile has managed to maintain higher savings levels than before 2019, with customers boasting FICO scores above 740 showing healthy spending and payment behaviors. In contrast, lower FICO score individuals are experiencing greater challenges as they face increased borrowing and declining payment rates, heavily influenced by high inflation and interest rates.
The Federal Reserve has maintained interest rates at a peak of 5.25-5.5%, awaiting stabilization in inflation metrics towards a target of 2% before implementing anticipated rate cuts.
While banks are preparing for possible defaults in the latter part of the year, current data does not indicate a crisis in consumer credit, according to Mulberry. He is particularly monitoring the differences between homeowners and renters during the pandemic. Homeowners who secured low fixed rates on their mortgages are less affected by the rise in interest rates, while renters, who have not had similar financial advantages, are facing increased stress due to rising rents, which have soared over 30% nationally since 2019, coupled with grocery costs rising by 25%.
Overall, the latest earnings reports suggest no significant new issues concerning asset quality. Positive trends in revenues, profits, and net interest income indicate that the banking sector remains fundamentally strong. Mulberry stated that while there are signs of resilience in the financial system, ongoing high-interest rates could introduce additional stress going forward.