With interest rates reaching their highest levels in over 20 years and inflation impacting consumers, major banks are bracing for increased risks associated with their lending strategies.
In the second quarter of the year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions are funds earmarked by financial institutions to cover potential losses from credit risks, including overdue debts and commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses rose significantly to $21.8 billion by the end of the quarter, more than tripling its reserves from the prior period, and Wells Fargo’s provisions amounted to $1.24 billion.
These provisions indicate that banks are preparing for a more challenging economic environment, where both secured and unsecured loans could lead to larger losses. A recent analysis by the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also climbing as consumers exhaust their pandemic savings and increasingly rely on credit. By the first quarter of this year, credit card balances hit $1.02 trillion, marking the second consecutive quarter that totals exceeded this level, according to TransUnion. Additionally, the commercial real estate sector remains vulnerable.
“We are still emerging from the COVID era, and much of the support for consumer banking was fueled by the stimulus package,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Challenges for banks are expected to arise in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that quarterly provisions do not fully reflect credit quality over the last three months, but rather banks’ expectations for the future.
He noted a shift in how banks manage their provisioning processes, suggesting that macroeconomic forecasts now play a more significant role than in the past when growing loan delinquencies directly influenced provisions.
In the short term, banks are projecting a slowdown in economic growth, an increase in unemployment rates, and potential interest rate cuts later this year. This environment could lead to more delinquencies and defaults as the year closes.
Citigroup’s chief financial officer, Mark Mason, emphasized that concerns seem to be more pronounced among lower-income consumers, who have seen their financial reserves diminish in recent years.
“While the overall U.S. consumer remains resilient, there is a notable divergence in performance across different credit and income brackets,” Mason reported in a recent analyst call. “Only the highest income quartile has maintained more savings than before 2019, with customers in the upper FICO score range driving spending growth and keeping high payment rates. In contrast, those in lower FICO bands are struggling with declining payment rates and are increasingly reliant on credit due to the pressures of high inflation and interest rates.”
The Federal Reserve has maintained interest rates between 5.25% and 5.5%, a level not seen in 23 years, while awaiting inflation measures to stabilize around the target of 2% before implementing any significant rate cuts.
Despite banks preparing for a potential increase in defaults later in the year, Mulberry noted that current default rates do not indicate a consumer crisis. He is particularly monitoring the divide between homeowners and renters post-pandemic.
“Although rates have increased substantially, homeowners locked in low fixed rates and are not experiencing the same level of financial strain. Renters missed this opportunity,” Mulberry stated. With rents increasing by over 30% nationwide since 2019 and grocery costs up 25%, those who rent are facing significant budget constraints.
Nonetheless, the recent earnings reports show that there are no new concerns regarding asset quality. Strong revenues, profits, and stable net interest income suggest a still-robust banking sector.
“There’s notable strength in the banking sector that is reassuring, confirming that the foundations of the financial system remain solid at this moment,” Mulberry added. “However, we continue to monitor the situation closely, as prolonged high interest rates can lead to increased stress.”