With interest rates at their highest in over two decades and inflation continuing to challenge 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 represent funds that financial institutions set aside to address potential credit risks, including delinquent loans and bad debt, particularly in sectors such as 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 allowance for credit losses reached $21.8 billion by the quarter’s end, reflecting a more than threefold increase from the last quarter. Wells Fargo recorded provisions of $1.24 billion.
These provisions indicate that banks are preparing for a more challenging economic landscape, where both secured and unsecured loans may lead to larger losses. A recent study by the New York Federal Reserve highlighted that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards is increasing, along with delinquency rates, as people deplete the savings they accumulated during the pandemic and increasingly depend on credit. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total balances surpassed one trillion dollars. Additionally, commercial real estate remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, mentioned, “We’re still coming out of this COVID era, and mainly when it comes to banking and the health of the consumer, it was all of the stimulus that was deployed to the consumer.”
However, difficulties for banks may emerge in the coming months. Mark Narron from Fitch Ratings noted that the provisions reported each quarter do not solely reflect prior credit quality but are also based on banks’ future expectations.
Interestingly, banks have shifted from a traditional model where rising loan failures drove up provisions to one where macroeconomic conditions influence provisioning levels, according to Narron.
In the immediate future, banks forecast slower economic growth, increased unemployment, and possible interest rate cuts in September and December, which may lead to higher delinquency and default rates toward the end of the year.
Citi’s chief financial officer, Mark Mason, pointed out that red flags are particularly evident among lower-income consumers, whose savings have declined since the pandemic. He emphasized the disparity in savings behavior, noting that only the highest income quartile has more savings than in early 2019, with consumers holding over a 740 FICO score driving spending growth while lower FICO band customers are facing tougher payment challenges due to high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation toward the central bank’s 2% target before implementing anticipated rate cuts.
Despite banks’ preparations for a potential rise in defaults later this year, current default rates do not suggest an immediate consumer crisis, as observed by Mulberry. He noted a significant difference between homeowners and renters; homeowners, having secured low fixed-rate mortgages, are largely shielded from the financial strain that renters are experiencing as rental costs have surged over 30% nationally since 2019.
The latest earnings reports indicate that asset quality remains stable, with strong revenues, profits, and resilient net interest income serving as positive signs for the banking sector. Mulberry remarked on the overall health of the financial system, stating, “There’s some strength in the banking sector that I don’t know was totally unexpected, but I think it’s certainly a relief to say that the structures of the financial system are still very strong and sound.” He cautioned, however, that continued high interest rates could lead to increasing stress.