With interest rates at the highest levels in over twenty years and inflation increasingly impacting consumers, major banks are preparing for heightened risks in their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions represent the capital that banks set aside to address potential losses stemming from credit risks, including delinquent accounts and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, more than three times its previous quarter’s allocation, and Wells Fargo reported provisions of $1.24 billion.
These increased provisions signal that banks are preparing for a riskier environment, where both secured and unsecured loans could lead to greater losses. The New York Federal Reserve recently reported that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Furthermore, credit card issuance and related delinquency rates are rising as consumers exhaust their pandemic-era savings and increasingly rely on credit. By the first quarter of this year, total credit card balances reached $1.02 trillion, marking the second consecutive quarter of exceeding a trillion dollars, according to TransUnion. The commercial real estate sector also remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking landscape and consumer health are still recovering from the COVID-19 pandemic and the extensive stimulus measures that supported consumers during that time.
Challenges for banks may emerge in the forthcoming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that the provisions recorded by banks in any given quarter do not solely reflect recent credit quality but rather their expectations for future trends.
Economically, banks anticipate slower growth, rising unemployment rates, and potential interest rate cuts in September and December, possibly leading to increased delinquencies and defaults by year-end.
Citi’s chief financial officer, Mark Mason, highlighted that the most concerning indicators are primarily seen among lower-income consumers, whose savings have diminished since the pandemic.
Mason remarked that while the overall U.S. consumer is currently resilient, there are noticeable differences based on credit scores and income levels. Only the highest-income quartile has seen an increase in savings since early 2019, and consumers with FICO scores over 740 are primarily responsible for spending growth and high payment rates. Conversely, those with lower credit scores are experiencing significant declines in payment rates and are borrowing more due to the severe impact of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25% to 5.5%, awaiting stabilization in inflation measures toward the central bank’s 2% target before considering necessary rate cuts.
Despite banks preparing for potential defaults in the latter half of the year, current default rates do not indicate a looming consumer crisis, according to Mulberry. He is particularly observing the difference between homeowners and renters from the pandemic period. Homeowners, who secured low fixed rates on their mortgages, are less affected by rising rates, while renters are feeling the financial strain, given that rental prices have surged by over 30% since 2019, alongside a 25% rise in grocery costs.
In conclusion, the recent earnings reports indicate that there is no significant concern regarding asset quality at this time, according to Narron. Strong revenues, profits, and robust net interest income are reaffirming a solid banking sector. Mulberry noted that while the financial system remains resilient, extended high interest rates could pose growing stresses in the future.