Amidst the highest interest rates in over two decades and ongoing inflationary pressures, major banks are bracing for increased risks associated with their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses when compared to the previous quarter. These provisions are funds set aside by financial institutions to cover potential losses linked to credit risks, such as overdue loans and poor debt performance, particularly in commercial real estate (CRE) financing.
JPMorgan allocated $3.05 billion to credit loss provisions in Q2; Bank of America set aside $1.5 billion; Citigroup’s total climbed to $21.8 billion, significantly more than the previous quarter; and Wells Fargo recorded $1.24 billion in provisions.
This preparation indicates that banks are anticipating a more volatile lending environment, where both secured and unsecured loans could result in larger losses. The latest analysis from the New York Federal Reserve revealed that U.S. households owe a staggering $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card usage and delinquency rates have risen as Americans tap into their savings amassed during the pandemic, increasing reliance on credit. The total credit card balance reached $1.02 trillion in the first quarter, marking the second consecutive quarter in which balances crossed the trillion-dollar threshold, according to TransUnion. Additionally, the CRE sector is facing its own challenges.
“We are still emerging from the COVID period, particularly in relation to banking and consumer health, driven largely by the stimulus that was provided,” commented Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, challenges for banks are expected to emerge in the coming months.
“The provisions you see in any given quarter do not simply reflect credit quality from the past three months, but rather the banks’ expectations for the future,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
Narron added that the current trend signifies a departure from traditional practices where rising defaults would lead to increased provisions, shifting instead towards a model influenced primarily by macroeconomic forecasts.
For the near future, banks are predicting slowed economic growth, a rise in unemployment, and anticipated interest rate cuts later this year in September and December. This scenario could lead to higher delinquency rates and defaults as the year closes out.
Citi’s CFO Mark Mason highlighted concerns particularly among lower-income consumers, who have seen their savings dwindle since the pandemic.
“While we still see a resilient U.S. consumer overall, we also observe a divergence based on income and credit scores,” Mason stated during a recent analyst call. “Only the highest income quartile has managed to maintain more savings than they had at the start of 2019. Consumers with credit scores above 740 are driving growth in spending and maintaining high payment rates, while those with lower scores are experiencing a significant decline in payment rates and increasing borrowing as they grapple with high inflation and interest rates.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% while it awaits signs of inflation stabilization towards the central bank’s 2% target before proceeding with expected rate cuts.
Despite preparations for potential defaults, current default rates do not yet indicate a looming consumer crisis, according to Mulberry. He observed a notable distinction between homeowners and renters during the pandemic.
“Yes, rates have increased significantly since then, but homeowners locked in very low fixed rates on their mortgages, so they are not feeling the financial pressure as acutely,” Mulberry noted. “Renters, on the other hand, missed out on that opportunity.”
With rents rising over 30% nationwide from 2019 to 2023 and grocery costs climbing 25% during the same period, renters who didn’t secure low rates are experiencing significant financial stress compared to wage growth.
Currently, the most important takeaway from the latest earnings reports is that “there has been nothing alarming this quarter concerning asset quality,” stated Narron. The banking sector continues to show strong revenues, profits, and resilient net interest income, indicating robust health within the industry.
“There is some strength in the banking sector that might not have been entirely anticipated, but it’s reassuring to confirm that the fundamentals of the financial system remain strong at this time,” Mulberry remarked. “Nonetheless, we are closely monitoring the situation, as prolonged high-interest rates will inevitably lead to heightened strain.”