With interest rates reaching levels not seen in over 20 years and inflation exerting pressure on consumers, major banks are bracing 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 refer to the funds set aside by financial institutions to manage potential losses from credit risks, including delinquent debts and lending practices such as commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses during the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses climbed to $21.8 billion by the end of the quarter, a significant increase from previous months, and Wells Fargo reported provisions of $1.24 billion.
These provisions indicate that banks are preparing for a riskier lending environment, where both secured and unsecured loans may lead to greater financial losses. A recent analysis by the New York Federal Reserve highlighted that Americans currently owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards and the subsequent increase in delinquency rates are also on the rise as consumers increasingly rely on credit and deplete their pandemic savings. In the first quarter, credit card balances topped $1.02 trillion, marking the second consecutive quarter where total balances exceeded this milestone, according to TransUnion. Additionally, the commercial real estate sector remains vulnerable.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking sector is still recovering from the COVID-19 pandemic, largely due to the stimulus measures that supported consumers during this period.
Looking ahead, any challenges for banks are anticipated to emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that the provisions seen in a quarterly report do not precisely reflect the credit quality from recent months but rather indicate banks’ expectations for future conditions.
As economic growth is projected to slow, unemployment rates to rise, and interest rate cuts to potentially occur in September and December, banks are preparing for possible increases in delinquencies and default rates as the year concludes.
Mark Mason, Citigroup’s chief financial officer, pointed out that concerns about rising defaults are particularly present among lower-income consumers, who have seen their savings diminish since the pandemic.
While the overall U.S. consumer market appears resilient, there is marked disparity across different income groups. Mason revealed that only the highest-income households show more savings now than they did at the beginning of 2019. Consumers with high credit scores are driving spending growth and maintaining high payment rates, whereas those with lower credit scores are experiencing a decline in payment rates and are taking on more debt as they deal with the impacts of high inflation and interest rates.
The Federal Reserve is maintaining interest rates at a high range of 5.25-5.5%, awaiting stability in inflation metrics towards its 2% target before potentially implementing the long-anticipated rate cuts.
Despite the banking sector’s preparations for increased defaults later this year, the current default rates do not suggest an impending consumer crisis, as noted by Mulberry. He is particularly attentive to the differences between homeowners and renters in the wake of the pandemic.
While interest rates have significantly increased since that time, homeowners who secured low fixed rates are not feeling the financial strain to the same degree as renters. Renters, facing nationwide rent increases of over 30% from 2019 to 2023 and a 25% rise in grocery costs, are experiencing greater financial stress.
At present, the key takeaway from recent earnings reports is that overall asset quality remains stable. Despite concerns, the banking sector continues to report strong revenues, profits, and resilient net interest income, indicating a healthy financial system.
Although Mulberry acknowledges the strength observed in the banking sector, he emphasizes the importance of monitoring the situation closely, as prolonged high interest rates could contribute to increased financial stress.