With interest rates hitting their highest levels in over 20 years and inflation continuing to impact consumers, major banks are bracing for increased risks associated with their lending activities.
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 that banks allocate to cover potential losses stemming from credit risks, which include delinquent debts and various types of loans, such as commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, representing a significant increase from the previous quarter, and Wells Fargo’s provisions totaled $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging financial environment, anticipating that both secured and unsecured loans could result in greater losses. A recent report from the New York Fed revealed that American households owe a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, the rate of credit card issuance and the corresponding delinquency rates are on the rise as people exhaust their pandemic-era savings and increasingly rely on credit. According to TransUnion, credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold. The commercial real estate sector also remains vulnerable.
“We are still recovering from the COVID era, especially regarding banking and consumer health, largely due to the stimulus that was provided to consumers,” commented Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any challenges facing banks are expected to materialize in the coming months.
“The provisions you see in any given quarter do not necessarily indicate credit quality for the past three months; instead, they reflect banks’ expectations for the future,” said Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He noted a shift from a historical model, where rising defaults prompted increased provisions, to a contemporary model driven by macroeconomic forecasts.
In the near future, banks are forecasting slowed economic growth, a higher unemployment rate, and two potential interest rate cuts later this year in September and December. This could lead to more delinquencies and defaults as the year ends.
Citi’s chief financial officer, Mark Mason, pointed out that these warning signs predominantly affect lower-income consumers, who have seen their savings diminish since the pandemic.
“While the overall U.S. consumer remains resilient, we observe a divergence in performance and behavior across different income levels,” Mason indicated during a recent call with analysts.
He noted that only the top income quartile has greater savings than they did in early 2019, and consumers with credit scores above 740 are driving growth in spending and maintaining high payment rates. In contrast, lower FICO score borrowers are experiencing a significant decline in payment rates and are borrowing more due to the pressures of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting inflation metrics to stabilize toward the central bank’s 2% target before contemplating rate cuts.
Despite banks preparing for potential defaults later this year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He is closely monitoring the differences between homeowners and renters from the pandemic era.
“Yes, rates have increased significantly since then, but homeowners have locked in low fixed rates on their debt, so they aren’t feeling that pressure as much,” Mulberry explained. “Renters, on the other hand, who haven’t secured low rates, are dealing with rental prices that have surged more than 30% nationwide since 2019.”
With rents increasing over 30% between 2019 and 2023 and grocery costs rising by 25% during the same timeframe, renters are facing severe budget pressures, according to Mulberry.
Overall, the major takeaway from the latest earnings reports is that there were no new issues regarding asset quality. In fact, robust revenues, profits, and stable net interest income are encouraging signs for the banking sector.
“There’s some strength in the banking sector that perhaps wasn’t entirely anticipated, but it’s reassuring to see that the foundations of the financial system are still solid,” Mulberry stated. “However, we are closely monitoring the situation, as prolonged high interest rates will continue to exert stress on the system.”