With interest rates at their highest in over 20 years and inflation putting pressure on consumers, major banks are bracing for increased risks related to their lending activities.
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 are funds set aside by financial institutions to cover potential losses from credit risks, including bad debts and delinquent loans, particularly in 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 credit loss allowance reached $21.8 billion by the end of the quarter, more than tripling its reserves from the prior quarter, and Wells Fargo had $1.24 billion in provisions.
These increased reserves indicate that banks are preparing for a more challenging environment, as both secured and unsecured loans may lead to larger losses. A recent analysis from the New York Federal Reserve found that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise as consumers begin to exhaust their pandemic-era savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter in which total cardholder balances exceeded this threshold, according to TransUnion. The commercial real estate sector also continues to face challenges.
As Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted, the fallout from the COVID-19 pandemic continues to impact banking and consumer health primarily because of the stimulus measures that were provided during that time.
However, any significant issues for banks are expected to emerge in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that the provisions reported in any given quarter do not necessarily indicate recent credit quality but rather reflect banks’ expectations for future conditions.
Currently, banks foresee slowing economic growth, rising unemployment, and two anticipated interest rate cuts later this year in September and December, potentially leading to more delinquencies and defaults as the year progresses.
Citi’s chief financial officer, Mark Mason, highlighted that red flags seem to be especially prevalent among lower-income consumers, whose savings have diminished since the pandemic. He pointed out that while the overall U.S. consumer remains resilient, behavior and performance vary significantly across different income groups.
Mason further stated that only the top income quartile has managed to increase their savings compared to early 2019, with those customers boasting FICO scores above 740 driving spending growth and maintaining high payment rates. Conversely, customers with lower FICO scores are experiencing steeper declines in payment rates and increasing borrowing as they are more severely affected by rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilizing inflation measures to reach its target of 2% before implementing any rate cuts.
Despite banks expecting more defaults in the latter part of the year, defaults have not yet risen to a level indicative of a consumer crisis, according to Mulberry. He is monitoring the distinction between homeowners and renters during this period. Homeowners, who locked in low fixed rates, are not experiencing the same financial strain as renters, who are facing significant rent increases since 2019.
With rent surging over 30% nationwide and grocery costs rising 25%, renters who didn’t benefit from fixed-rate mortgages are feeling financial pressure more acutely.
For the time being, analysts suggest that there were no significant changes in asset quality during the latest earnings reports. Strong revenues, profits, and resilient net interest income are all encouraging signs for the banking sector.
Mulberry remarked that while the current strength in the banking sector is not entirely unexpected, it is reassuring to see the financial system’s structures remain robust. However, he cautioned that as long as interest rates remain elevated, it could result in increasing stress on banks.