As interest rates reach their highest levels in over two decades and inflation continues to impact 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 represent the funds that banks set aside to mitigate possible losses from credit risks, which include delinquent loans and bad debts, particularly in the commercial real estate sector.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America reported provisions of $1.5 billion. Citigroup’s allowance for credit losses soared to $21.8 billion by the end of the quarter, more than tripling its reserves from the prior quarter, and Wells Fargo set aside $1.24 billion.
These increased reserves indicate that banks are preparing for a potentially tougher lending environment, where both secured and unsecured loans may lead to larger losses. A recent report from the New York Fed indicated that American consumers are currently carrying a collective debt of $17.7 trillion in various forms, including consumer loans, student loans, and mortgages.
Meanwhile, credit card issuance is on the rise, along with delinquency rates, as many individuals deplete their pandemic-era savings and increasingly rely on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter where the total exceeded one trillion dollars, according to TransUnion. The commercial real estate sector is also facing significant uncertainty.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted that we are still emerging from the impacts of the COVID-19 pandemic, particularly regarding banking and consumer health, which were heavily influenced by government stimulus.
However, the challenges facing banks may not materialize until later this year. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported in any quarter do not necessarily represent the current state of credit quality; rather, they reflect banks’ future expectations.
In the short term, banks anticipate slower economic growth, an increase in unemployment, and potential interest rate cuts in September and December, which could amplify delinquencies and defaults as the year progresses.
According to Citi’s chief financial officer Mark Mason, these risks seem to be most pronounced among lower-income consumers, who have seen their savings diminish since the pandemic began. While the overall U.S. consumer appears resilient, performance varies significantly across different income levels and credit scores.
Mason pointed out that only the top income quartile has more savings now compared to the beginning of 2019, and that higher FICO score customers are primarily driving spending growth and maintaining payment rates. In contrast, consumers with lower credit scores are struggling more visibly with rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, pending stabilization of inflation toward its 2% target before implementing expected rate cuts.
Despite banks preparing for more defaults later this year, Mulberry noted that defaults have not yet risen significantly, suggesting a looming consumer crisis is not imminent. He highlighted the contrast between homeowners who locked in low fixed-rate mortgages and renters who missed that opportunity, indicating that those renters are facing significant budget pressures due to rising rents and food costs, which have surged more than 30% and 25%, respectively, since 2019.
In conclusion, the latest earnings reports indicate no significant shifts in asset quality among banks. Instead, strong revenues, profits, and stable net interest income suggest that the banking sector remains fundamentally healthy. Nonetheless, Mulberry cautioned that prolonged high interest rates could lead to increased stress in the financial system.