Amidst the backdrop of interest rates hitting a more than two-decade peak and persistent inflation impacting consumers, major banks are positioning themselves to confront heightened risks tied to their lending practices.
In the second quarter, leading financial institutions including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions serve as a financial buffer against potential losses stemming from credit risk, which encompasses unpaid debts and lending activities, particularly in commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, marking a significant increase from the prior quarter, and Wells Fargo reported provisions amounting to $1.24 billion.
These increased reserves indicate that banks are preparing for a more precarious environment, where both secured and unsecured loans might lead to larger losses. A study by the New York Fed revealed that American households currently hold a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, the trend of rising credit card issuance and delinquency rates is becoming more pronounced as individuals deplete their savings accrued during the pandemic, leading them to increasingly rely on credit. Credit card debt reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where totals surpassed the trillion-dollar milestone, according to data from TransUnion. The situation in commercial real estate also remains uncertain.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the lingering effects of the COVID era, coupled with considerable consumer stimulus, shape the current banking landscape.
However, potential challenges for banks may arise in the upcoming months. Mark Narron, a senior director at Fitch Ratings, pointed out that current provisions illustrate banks’ expectations for future credit quality rather than reflecting past performance.
In the short term, banks anticipate slowing economic growth, rising unemployment, and projections for two interest rate cuts later in the year, which could lead to an increase in delinquencies and defaults.
Citi’s chief financial officer Mark Mason highlighted concerning trends among lower-income consumers, who have suffered a decline in savings since the pandemic’s onset. While the overall U.S. consumer remains resilient, a divide in performance based on income and credit scores is evident.
Mason observed that only the highest income quartile has managed to increase its savings since early 2019, with borrowing patterns heavily skewed towards those with higher credit scores. In contrast, lower credit score customers are experiencing significant drops in payment rates and are borrowing more due to the pressures of high inflation and interest rates.
The Federal Reserve’s decision to maintain interest rates at a 23-year high of 5.25-5.5% reflects its strategy of waiting for inflation to stabilize before contemplating anticipated rate cuts.
Despite banks gearing up for a potential rise in defaults later in the year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He is paying close attention to the disparity between homeowners and renters during this time.
While interest rates have surged, homeowners who secured low fixed rates on their debts are largely insulated from financial pressure, unlike renters, who have faced increased costs without the same advantages.
Since 2019, national rents have surged over 30%, alongside grocery prices rising 25%, placing an additional financial strain on renters as wage growth has not kept pace.
For now, the key takeaway from the latest earnings reports is the stability in asset quality, with strong revenues and profits highlighting the banking sector’s ongoing health. Mulberry stated that while some strength in the banking system is encouraging, the prolonged high-interest rate environment could escalate stress levels in the future.