As interest rates reach more than two-decade highs and inflation pressures consumers, major banks are bracing for increased risks stemming from 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 cover potential losses from credit risk, including delinquent debts and loans, particularly in commercial real estate (CRE).
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 at the quarter’s end, significantly higher than its provisions in the previous quarter. Wells Fargo reported provisions totaling $1.24 billion.
These increased provisions suggest that banks are preparing for a more challenging environment, in which both secured and unsecured loans may lead to greater losses for some of the nation’s largest financial institutions. A recent analysis by the New York Federal Reserve revealed that Americans owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance has surged, with delinquency rates also on the rise as consumers deplete their pandemic-era savings and increasingly rely on credit. According to TransUnion, credit card balances hit $1.02 trillion in the first quarter of the year, marking the second consecutive quarter where total cardholder balances exceeded the trillion-dollar threshold. Furthermore, the CRE sector remains in a delicate situation.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector is still recovering from the impacts of COVID-19, particularly regarding consumer health, which had been bolstered by significant government stimulus.
However, potential problems for banks may emerge in the upcoming months. Mark Narron, a senior director at Fitch Ratings, emphasized that the provisions reported in any given quarter do not necessarily reflect recent credit quality but rather what banks anticipate for the future.
According to Narron, banks are forecasting slower economic growth, rising unemployment, and two interest rate cuts expected later this year, in September and December. Such conditions could lead to an increase in delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, pointed out that these concerning trends appear to be concentrated among lower-income consumers, who have seen their savings dwindle since the pandemic. He observed that while the U.S. consumer overall remains resilient, there is notable divergence in behavior based on income level and credit scores.
Currently, only the highest-income quartile has more savings than before 2019, with consumers in the over-740 FICO score bracket driving spending growth and maintaining high payment rates. In contrast, lower income and lower FICO score consumers are facing increased financial strain due to high inflation and interest rates.
With the Federal Reserve maintaining interest rates at a 23-year high of 5.25-5.5%, the bank is awaiting inflation figures to stabilize closer to its targeted 2% before implementing anticipated rate cuts.
While banks are gearing up for a rise in defaults later this year, Mulberry noted that defaults have not yet escalated to levels indicative of a consumer crisis. He remarked on the difference between homeowners and renters during the pandemic, stating that many homeowners secured low fixed-rate mortgages and are largely unaffected by the current rate hikes, whereas renters, who faced increasing rent costs, are experiencing greater financial pressure.
Although concerns linger, current earnings reports suggest that asset quality remains stable. Narron commented that the banking sector is showing strong revenues, profits, and robust net interest income, which is a positive sign for the financial industry.
Mulberry concluded that while the banking sector displays resilience, ongoing high interest rates may continue to cause stress in the longer term.