With interest rates reaching highs not seen in over two decades and inflation continuing to affect consumers, major banks are taking precautions against potential risks in their lending practices.
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 banks to cover anticipated losses from credit risk, including delinquent debts and loans, particularly in commercial real estate.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, more than tripling its buildup from the previous quarter, and Wells Fargo’s provisions totaled $1.24 billion.
These reserves indicate that banks are preparing for a more challenging economic landscape, as both secured and unsecured loans may lead to greater losses for these financial institutions. A recent analysis from the New York Federal Reserve revealed that Americans carry a total debt of $17.7 trillion from consumer loans, student loans, and mortgages.
Furthermore, the issuance of credit cards and subsequent delinquency rates are climbing as many individuals deplete their pandemic savings and increasingly rely on credit. Credit card debts reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter in which total cardholder balances surpassed the trillion-dollar threshold. The commercial real estate sector also faces significant challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the impacts of the COVID-19 era and the consumer stimulus packages have shaped banking conditions.
However, the real test for banks may come in the upcoming months. Mark Narron, a senior director at Fitch Ratings, explained that quarterly provisions do not directly reflect credit quality from the prior three months, but rather are forecasts based on future expectations.
Narron indicated that banks are currently anticipating slower economic growth, higher unemployment rates, and two interest rate cuts later this year in September and December, which could lead to more delinquencies and defaults by the end of the year.
Citi’s chief financial officer Mark Mason pointed out concerning trends among lower-income consumers, who have experienced significant declines in their savings since the pandemic’s onset. He highlighted a growing performance divergence among different income and credit score groups.
According to Mason, only the highest income quartile has more savings than before 2019, and those with FICO scores above 740 are primarily driving spending growth while maintaining robust payment rates. In contrast, customers with lower FICO scores are facing steeper drops in payment rates and increasing borrowing needs due to heightened inflation and interest rates.
The Federal Reserve maintains interest rates between 5.25% and 5.5%, a 23-year high, as it awaits stabilization in inflation towards the central bank’s 2% target before implementing expected rate cuts.
Despite banks bracing for increased defaults in the latter half of the year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He is particularly observing the disparity between homeowners and renters during the pandemic period.
Though interest rates have risen significantly, many homeowners secured low fixed rates on their debts, shielding them from immediate financial strain. Conversely, renters, who did not benefit from such opportunities, are grappling with escalating rental costs, which have surged over 30% nationwide since 2019, alongside a 25% rise in grocery prices.
Overall, analysts assert that the latest earnings reports reveal no new concerns regarding asset quality. The banking sector continues to show strong revenues, profits, and resilient net interest income, signaling overall stability.
Mulberry commented on the strength of the banking sector, noting that while some unexpected resilience exists, ongoing high interest rates could intensify stress over time.