With interest rates reaching over two-decade highs and inflation affecting consumers, major banks are preparing for increased risks in 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 banks set aside to cover potential losses from credit risk, which includes bad debt and 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 allowance for credit losses was $21.8 billion at the end of the quarter, more than tripling its provisions from the previous quarter, and Wells Fargo allocated $1.24 billion.
These provisions indicate that banks are preparing for a more challenging economic environment, where both secured and unsecured loans could lead to greater losses. A recent report by the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as individuals deplete their pandemic-era savings and increasingly turn to credit. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter that total balances exceeded the trillion-dollar threshold. The commercial real estate sector also remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector is still emerging from the impacts of COVID-19, largely influenced by government stimulus to consumers.
Banking challenges are expected to arise in the months ahead. Mark Narron, a senior director at Fitch Ratings, mentioned that current provisions are often more predictive of future credit quality rather than reflecting recent performance.
The banks are forecasting a slowdown in economic growth, a rise in unemployment, and potential interest rate cuts later this year in September and December, which could lead to increased delinquencies and defaults toward year-end.
Citi’s CFO Mark Mason highlighted that issues appear to be most pronounced among lower-income consumers who have depleted their savings since the pandemic began. While there is overall resilience in the U.S. consumer market, Mason pointed out a significant divergence in spending and payment behavior across income levels and credit scores.
Currently, only the highest-income groups have maintained higher savings since early 2019, with those having credit scores above 740 driving spending growth. Conversely, lower-income consumers are experiencing significant declines in payment rates and borrowing more due to the pressures of high inflation and interest rates.
The Federal Reserve has kept interest rates at a 23-year high of 5.25-5.5%, awaiting stability in inflation to approach its target of 2% before implementing anticipated rate cuts.
Despite banks bracing for an uptick in defaults later in the year, they are not currently witnessing a rate of defaults that suggests a consumer crisis, according to Mulberry. He is observing the contrast between homeowners and renters from the pandemic period.
Homeowners who secured fixed-rate mortgages during that time have not felt the financial strain as acutely as renters, who have faced over a 30% increase in rents and a 25% rise in grocery prices since 2019, leading to significant stress on their monthly budgets.
In the latest earnings announcements, the key takeaway is that there have been no new issues regarding asset quality. Strong revenues, profits, and resilient net interest income are positive signs for the banking sector.
Mulberry expressed optimism about the banking sector’s current strength, though he cautioned that prolonged high interest rates could lead to increased stress in the future.