With interest rates at their highest in over two decades and inflation impacting consumers, large banks are bracing for potential risks associated with their lending practices.
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 set aside by banks to mitigate potential losses from credit risk, which encompasses overdue debts and loans, including those related to commercial real estate.
In detail, JPMorgan allocated $3.05 billion for credit loss provisions, while Bank of America set aside $1.5 billion. Citigroup raised its allowance for credit losses to $21.8 billion by the end of the quarter, a significant increase from the previous quarter, and Wells Fargo reported provisions of $1.24 billion.
These increased reserves suggest that banks are preparing for a potentially volatile environment where both secured and unsecured loans could lead to larger losses. A recent New York Fed study revealed that Americans collectively owe $17.7 trillion across various consumer loans, including student loans and mortgages.
Additionally, credit card issuance and subsequent delinquency rates are climbing as many consumers exhaust their pandemic-era 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 that total cardholder balances exceeded the trillion-dollar threshold. The commercial real estate sector is also facing significant challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked on the current environment, highlighting that the banking sector’s health is still influenced by the fiscal stimulus provided to consumers during the pandemic.
However, experts caution that any real issues for banks may lie ahead. Mark Narron, a senior director within Fitch Ratings’ Financial Institutions Group, explained that current provisioning figures do not directly reflect credit quality for the recent past, but rather what banks anticipate will occur moving forward.
Currently, banks foresee a slowdown in economic growth, a rise in unemployment rates, and the potential for two interest rate cuts later this year, which could exacerbate delinquencies and defaults as the year progresses.
Citigroup’s CFO, Mark Mason, pointed out that warning signs are primarily evident among lower-income consumers, whose savings have diminished post-pandemic. He noted disparities in consumer spending behavior based on income and credit scores, indicating that only the highest income quartile has managed to increase savings since early 2019. Consequently, consumers with lower credit scores are experiencing increased borrowing and payment difficulties due to high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% while monitoring inflation to stabilize towards its 2% target prior to implementing anticipated rate cuts.
Despite the growing concern over potential defaults in the latter half of the year, analysts like Mulberry report that defaults have not surged to a level indicative of a consumer crisis. He emphasizes the difference in the financial situations of homeowners, who locked in low fixed rates during the pandemic, and renters, who face escalating rental costs without having secured favorable rates.
With rents rising over 30% nationwide since 2019 and grocery costs increasing by 25% in the same timeframe, renters, unlike homeowners, are facing greater financial pressure.
For now, the key takeaway from the recent earnings reports is that the overall asset quality remains stable, according to Narron. The banking sector continues to show strong revenues, profits, and solid net interest income, indicating a resilient industry.
Mulberry concluded that while there are positive signs within the banking sector, ongoing high interest rates could lead to increased stress, and the situation warrants close monitoring.