With interest rates at their highest in over two decades and ongoing inflation impacting consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all reported heightened provisions for credit losses compared to the previous quarter. These provisions are funds set aside by banks to mitigate potential losses from credit risk, which can include overdue accounts and poor lending outcomes, particularly in commercial real estate (CRE).
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, representing more than a threefold increase from the previous quarter, and Wells Fargo provisioned $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging lending landscape, where both secured and unsecured loans could lead to significant losses. A recent report from the New York Federal Reserve highlighted that Americans currently owe a staggering $17.7 trillion in consumer, student, and mortgage loans.
The issuance of credit cards and the associated delinquency rates are also climbing as many consumers exhaust their pandemic-era savings and increasingly rely on credit. According to TransUnion, credit card balances surpassed $1 trillion in the first quarter of this year, marking the second consecutive quarter above this threshold. Furthermore, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted, “We’re still emerging from the COVID era, largely due to the stimulus support provided to consumers.”
However, potential challenges for banks may arise in the upcoming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions are not merely reflections of past credit quality but are predictions of future trends.
The near-term outlook for banks suggests an anticipated slowdown in economic growth, a rise in unemployment, and two interest rate cuts expected later in the year. This could result in increased delinquencies and defaults as the year concludes.
Citigroup’s chief financial officer, Mark Mason, pointed out that concerns are particularly pronounced among lower-income consumers, who have seen their savings diminish since the pandemic began. He indicated that while the overall U.S. consumer remains relatively strong, there is notable variation in performance across income levels.
“Only the highest income quartile has more savings than they did at the start of 2019, and it is those with a FICO score over 740 who are driving spending growth and maintaining good payment rates,” Mason stated. In contrast, lower-income customers are experiencing significant declines in their payment rates and are borrowing more in response to rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, holding off on cuts until inflation approaches its 2% target.
Despite banks’ preparations for increased defaults, Mulberry maintains that current default rates do not indicate an impending consumer crisis. He is particularly monitoring the comparison between homeowners and renters during the pandemic period.
While interest rates have risen sharply since then, homeowners, having locked in low fixed rates, are not felt as significantly by the increases. Conversely, renters, who have faced more than 30% increases in rent and 25% hikes in grocery prices since 2019, are experiencing significant financial strain.
Overall, the recent earnings reports revealed no alarming trends in asset quality. Strong revenues and profits, along with resilient net interest income, suggest that the banking sector remains stable. Mulberry emphasized that the current strength of the financial system is a relief, although he noted that prolonged high interest rates could lead to increased stress.