As interest rates reach their highest levels in over two decades, and inflation continues to challenge consumers, major banks are preparing for increased 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 funds set aside by financial institutions to mitigate potential losses from credit risks, including overdue debts and lending, particularly in commercial real estate (CRE).
JPMorgan added $3.05 billion to its credit loss provisions in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses ballooned to $21.8 billion by the end of the quarter, more than tripling its reserve from the prior quarter, and Wells Fargo allocated $1.24 billion.
This accumulation of reserves indicates that banks are bracing for a more challenging lending environment where both secured and unsecured loans could lead to larger losses. An analysis by the New York Fed highlighted that Americans collectively owe $17.7 trillion across various loans, including consumer and student loans, as well as mortgages.
Moreover, credit card issuance is rising, with delinquency rates also on the upswing as many consumers draw down their pandemic-era savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector remains particularly vulnerable.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the financial landscape is still recovering from the COVID crisis, largely due to the stimulus measures provided to consumers.
However, potential difficulties for banks are anticipated in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, pointed out that the provisions banks make in any quarter reflect their expectations for future credit quality rather than past performance.
Currently, banks are forecasting a slowdown in economic growth, an increase in unemployment levels, and two interest rate reductions slated for September and December, which could lead to a rise in delinquencies and defaults as the year ends.
Mark Mason, Citi’s chief financial officer, indicated that warning signs are primarily concentrated among lower-income consumers, who have seen their savings deplete since the pandemic began.
Mason noted that only the highest income quartile appears to have maintained more savings than they had in early 2019. He stated that consumers with FICO scores above 740 are mainly driving spending growth and sustaining high payment rates. In contrast, those with lower FICO scores are facing significant declines in payment rates while increasing their borrowings amid high inflation and interest rates.
The Federal Reserve continues to maintain interest rates at a range of 5.25% to 5.5%, the highest in 23 years, as it awaits stabilization in inflation measures towards a 2% target before implementing the anticipated rate cuts.
Despite banks bracing for an uptick in defaults in the latter half of the year, current default rates do not yet signify a consumer crisis, according to Mulberry. He is particularly monitoring the distinction between homeowners and renters from the pandemic era.
He observed that although interest rates have risen significantly, homeowners were able to secure low fixed rates on their debts, mitigating their financial strain. Conversely, renters who did not have this opportunity are facing increased financial pressure due to rising rental costs.
Over the past few years, rent has soared over 30% nationwide, and grocery prices have surged by 25%. Renters, who could not lock in favorable rates, are experiencing the most significant financial stress as their rental expenses have outpaced wage growth.
Overall, the latest earnings reports indicate stability in asset quality, with strong revenues, profits, and robust net interest income being encouraging signs for the banking sector. Mulberry emphasized this stability, highlighting the continuing strength of the financial system. However, he cautioned that prolonged high-interest rates could introduce additional stress to the sector.