As interest rates reach highs not seen in over 20 years and inflation continues to pose challenges for consumers, major banks are gearing up for potential risks associated with 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 represent funds set aside by financial institutions to cover possible losses stemming from credit risks, which include delinquent debts and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit loss provisions in the latest quarter, while Bank of America set aside $1.5 billion. Citigroup reported an allowance for credit losses totaling $21.8 billion at the end of the quarter, representing a tripling of its credit reserve from the prior quarter. Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves indicate that banks are anticipating a riskier lending environment, where both secured and unsecured loans could lead to larger losses. A recent analysis from the New York Fed revealed that the total household debt in America has soared to $17.7 trillion, encompassing various types of consumer loans, student loans, and mortgages.
Credit card issuance is rising, along with delinquency rates, as consumers dip into their pandemic-era savings. TransUnion reported that credit card balances in the first quarter reached $1.02 trillion, marking the second consecutive quarter in which total balances surpassed the trillion-dollar threshold. Moreover, the commercial real estate sector remains in a vulnerable state.
Brian Mulberry, client portfolio manager at Zacks Investment Management, noted that the banking sector’s current state reflects the effects of extensive stimulus measures from the COVID-19 era on consumer health.
However, challenges for the banks are expected to arise in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions recorded in any quarter are indicative of banks’ expectations for future credit quality rather than past performance.
Observations suggest that banks forecast slower economic growth, a rising unemployment rate, and potential interest rate cuts later in the year. This may lead to increased delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, highlighted concerns particularly among lower-income consumers, many of whom have experienced a depletion of savings post-pandemic. He emphasized that while the overall U.S. consumer remains resilient, there is a notable disparity in financial health across different income levels.
Mason stated that only the top income quartile has seen an increase in savings since early 2019, with growth in spending and payment rates concentrated among high FICO score customers. In contrast, those with lower credit scores are facing significant challenges, as they are more affected by high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation towards its 2% target before considering rate cuts.
Despite banks bracing for an increase in defaults in the latter half of the year, the current rate of defaults does not yet signal a consumer crisis, according to Mulberry. He noted the distinction between homeowners during the pandemic, who secured low fixed rates, and renters who missed out on that opportunity.
With rental prices up over 30% nationwide since 2019 and grocery costs rising 25%, renters facing higher expenses without corresponding wage increases are under greater financial stress.
For now, one significant takeaway from the latest earnings reports is that asset quality remains stable. Strong revenues, profits, and resilient net interest income suggest that the banking sector is still in a healthy position.
Mulberry remarked on the overall strength of the banking sector, stating that while the situation is not entirely unexpected, it is reassuring to see that the financial system remains robust. However, he cautioned that ongoing high interest rates could induce more stress in the future.