As interest rates soar to levels not seen in over 20 years and inflation continues to pressure consumers, major banks are bracing for increased risks in their lending operations.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all augmented their provisions for credit losses, signaling caution in their lending strategies. These provisions are funds set aside to mitigate potential losses from credit risks, which include delinquent and bad debts as well as commercial real estate loans.
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 at the end of the quarter, marking a significant increase from the previous period, and Wells Fargo provided $1.24 billion.
These increased reserves highlight the banks’ anticipation of a more challenging environment. A recent analysis from the New York Fed indicated that U.S. consumers collectively owe $17.7 trillion in various loans, including consumer and student loans and mortgages.
The issuance of credit cards and delinquency rates are also climbing as consumers deplete their pandemic-era savings and increasingly turn to credit. Credit card debt hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total balances surpassed this threshold, according to TransUnion. Additionally, commercial real estate remains vulnerable.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the situation reflects ongoing consequences from the COVID-19 pandemic, particularly the economic stimulus distributed to consumers.
However, challenges for banks are projected to emerge in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that the provisions reported by banks may not accurately represent recent credit quality but rather reflect anticipated future conditions.
He commented that the trend has shifted from a reactive provision model to one driven by broader macroeconomic forecasts.
Looking ahead, banks expect slower economic growth, a rise in unemployment, and two anticipated interest rate cuts later this year. These factors may lead to an increase in delinquencies and defaults by year-end.
Citigroup’s CFO Mark Mason pointed out concerning trends among lower-income consumers, who have seen their savings decrease since the pandemic. He elaborated that while the overall U.S. consumer appears resilient, there is a notable divergence in performance and behavior across different income and credit score groups.
Mason mentioned that only the highest income quartile has experienced an increase in savings since the beginning of 2019, with those having scores over 740 driving spending growth. Conversely, customers in lower FICO score brackets are experiencing significant declines in payment rates and reliance on borrowing, particularly affected by high inflation and rising interest rates.
The Federal Reserve is maintaining its interest rates at a 23-year high of 5.25-5.5% as it monitors inflation, which it aims to stabilize at a target of 2% before proceeding with any cuts.
Despite banks preparing for a rise in defaults later this year, Mulberry noted that current default rates do not indicate an impending consumer crisis. He emphasized a key distinction between homeowners who secured low fixed rates during the pandemic and renters.
While interest rates have dramatically increased, homeowners are largely insulated from the impact due to their favorable fixed-rate loans, whereas renters have faced a substantial rise in costs due to escalating rental prices and inflation, leading them to experience greater financial strain.
Overall, the latest earnings reports indicate a stable banking sector, with no alarming shifts in asset quality. Positive results in revenues, profits, and net interest income suggest that the financial system remains robust. Nevertheless, Mulberry cautioned that the ongoing high interest rates could create more stress in the economy moving forward.