Amid high interest rates, which are at their highest in over two decades, and ongoing inflation affecting consumers, major banks are bracing for increased risks associated with their lending operations.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo each raised their provisions for credit losses compared to the previous quarter. These provisions represent funds that banks set aside to cover potential losses due to credit risk, including bad debts and loans such as those in commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citi’s allowance reached $21.8 billion, significantly increasing from the prior quarter; and Wells Fargo’s provisions totaled $1.24 billion.
These increased provisions indicate that banks are preparing for a potentially riskier lending environment, with both secured and unsecured loans posing a threat for considerable losses. An analysis from the New York Fed revealed that households owe a staggering $17.7 trillion in consumer and student loans, and mortgages.
Moreover, credit card issuance and delinquency rates are rising as many individuals deplete their pandemic savings and increasingly rely on credit cards. TransUnion reported that credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where this figure surpassed the trillion-dollar benchmark. The CRE sector remains particularly vulnerable as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the current banking and consumer landscape. He highlighted that the economic fallout from the pandemic, along with the stimulus deployed to consumers, is still being felt in the banking sector.
According to Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, the provisions banks set aside in one quarter are indicative of their projections for future credit quality, rather than merely reflecting past performance. He noted a shift in the banking system whereby macroeconomic forecasts now significantly influence provisioning practices.
Looking ahead, banks anticipate slower economic growth, a potential rise in the unemployment rate, and two interest rate cuts expected later this year. Such developments could lead to increased delinquencies and defaults by year-end.
Citi’s CFO Mark Mason pointed out that the warning signs primarily affect lower-income consumers, who have seen their savings diminish since the pandemic. He indicated that while the overall U.S. consumer remains resilient, there is a notable performance gap across different income levels and credit scores.
Mason further explained that only the top income quartile has retained more savings than at the start of 2019, with high-FICO score customers driving spending growth. In contrast, those with lower credit scores are experiencing a decline in payment rates and are increasingly relying on borrowed funds due to the pressures of inflation and interest rates.
The Federal Reserve is maintaining interest rates at a high of 5.25-5.5%, awaiting stabilization in inflation levels before implementing anticipated rate cuts.
While banks are preparing for potential defaults in the latter half of the year, current default rates do not yet indicate a consumer crisis, according to Mulberry. He noted that homeowners who locked in low fixed rates during the pandemic are not feeling the same financial strain as renters, who face rising rents and grocery costs without the same opportunity to secure favorable mortgage rates.
Overall, recent earnings reports from banks suggest stability within the sector, with strong revenues and profits indicating a healthy banking environment. Mark Narron remarked that there were no significant new issues in asset quality this quarter, highlighting a sound financial system amidst prevailing interest rate pressures.