As interest rates remain at their highest levels in over 20 years and inflation continues to pressure consumers, major banks are gearing up to face 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 that banks set aside to manage potential losses arising from credit risks, such as delinquent accounts and problematic lending, including 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 credit loss reserves reached $21.8 billion by the end of the quarter, more than tripling its previous quarter’s reserve buildup. Wells Fargo recorded provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for an increasingly risky environment, where both secured and unsecured loans could lead to greater losses. A recent analysis by the New York Federal Reserve revealed that Americans collectively owe $17.7 trillion on various consumer loans, including student and mortgage loans.
Rising credit card issuance is accompanied by increasing delinquency rates as consumers exhaust their pandemic-era savings and rely more on credit. Credit card balances hit $1.02 trillion in the first quarter this year, marking the second consecutive quarter that totals surpassed the trillion-dollar milestone, according to TransUnion. Meanwhile, the commercial real estate sector remains vulnerable.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted that the effects of the COVID-19 pandemic are still influencing consumer behavior and banking health, largely due to the stimulus measures implemented during that time.
However, any banking challenges are expected to materialize in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions do not necessarily reflect the recent credit quality but are instead forecasts of future conditions.
He highlighted a shift in banks’ provisioning practices, where macroeconomic forecasts are now a primary driver, moving away from historical methods where loan defaults would directly trigger increased provisions.
In the near future, banks are forecasting slowing economic growth, rising unemployment, and potential interest rate cuts later this year, which could lead to more delinquencies and defaults before the year concludes.
Citi’s chief financial officer, Mark Mason, remarked that warning signs are particularly evident among lower-income consumers, who have seen their savings diminish in the years following the pandemic.
While the overall U.S. consumer remains resilient, Mason indicated a stark contrast in performance across different income levels. Only consumers in the highest income bracket have managed to increase their savings since 2019, with high FICO score customers contributing to spending growth. Conversely, those in lower FICO brackets are experiencing declines in payment rates and are borrowing more due to the financial strains of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year peak of 5.25-5.5%, awaiting stabilization in inflation metrics towards the central bank’s 2% target before implementing anticipated rate reductions.
Despite banks bracing for greater defaults in the latter half of the year, Mulberry noted that defaults have not yet escalated to alarming levels indicative of a consumer crisis. Currently, he is monitoring the distinction between homeowners and renters from the pandemic era.
While interest rates have surged, homeowners have locked in low fixed rates on their debts, allowing them to navigate financial pressures more easily. Conversely, renters, facing a 30% increase in rents since 2019 alongside a 25% rise in grocery costs, are experiencing significant strain due to rising costs that have outpaced wage growth.
Overall, the latest earnings reports suggest that there have been no new issues regarding asset quality. Strong revenues, profits, and resilient net interest income indicate a largely healthy banking sector.
Narron concluded that the banking system remains robust, offering reassurance about its stability. However, Mulberry warned that prolonged high interest rates will inevitably introduce more stress on the system.