As interest rates remain at their highest levels in over 20 years and inflation continues to pressure consumers, major banks are bracing for potential challenges stemming from their lending activities.
In the second quarter of the year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions are funds that banks set aside to mitigate potential losses due to credit risks, which encompass delinquent accounts and bad debts, including loans related to commercial real estate.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter. Bank of America set aside $1.5 billion, while Citigroup’s allowance reached $21.8 billion at the end of the quarter, significantly more than its reserves from the previous quarter. Wells Fargo’s provisions totaled $1.24 billion.
These increased reserves indicate that banks are preparing for a more volatile environment, where both secured and unsecured loans may lead to greater losses. According to a recent analysis from the New York Fed, Americans currently owe a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance is climbing, with delinquency rates also on the rise as many consumers deplete their pandemic savings and turn to credit for financial support. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter when total cardholder balances surpassed the trillion-dollar threshold, as reported by TransUnion. Additionally, the commercial real estate sector remains in a fragile state.
Experts note that the economic landscape is still evolving post-COVID, largely influenced by past consumer stimulus measures. However, potential setbacks for the banking industry are expected in the upcoming months.
“Provisions reported in any given quarter do not solely reflect recent credit quality but indicate banks’ future expectations,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
He added that the industry has shifted from a historical model where rising loan defaults prompted increased provisions to a paradigm where macroeconomic forecasts drive decisions on reserve levels.
Currently, banks foresee slowing economic growth, rising unemployment, and two anticipated interest rate cuts later this year. This could lead to increased delinquency and default rates as the year progresses.
Citi’s CFO, Mark Mason, pointed out that warning signs appear particularly among lower-income consumers, who have seen their savings diminish since the pandemic began.
“While the overall U.S. consumer remains resilient, we observe significant differences in performance across income levels,” Mason noted during a recent analyst call.
Mason also observed that only the highest income quartile has more savings now than in early 2019. Consumers with credit scores above 740 are primarily driving spending increases and sustaining high payment rates, whereas those in lower scoring bands are experiencing sharper declines in payment rates and increased borrowing due to the ongoing impact of inflation and higher interest rates.
The Federal Reserve has kept interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation metrics before implementing much-anticipated rate cuts.
Despite banks bracing for a potential rise in defaults later this year, experts indicate that current default rates do not suggest an immediate consumer crisis. As Brian Mulberry from Zacks Investment Management noted, a clear distinction is emerging between homeowners and renters post-pandemic.
Although interest rates have surged, many homeowners secured low fixed rates on their loans, shielding them from significant financial distress. In contrast, renters who did not benefit from such opportunities are now facing increased stress as rents have soared over 30% nationwide since 2019, coupled with a 25% rise in grocery costs, outpacing wage growth.
Nonetheless, the recent earnings reports revealed no new concerns regarding asset quality, emphasizing robust revenues, profits, and stable net interest income as signs of a healthy banking sector.
“There’s some strength in the banking sector that may not have been entirely anticipated, offering reassurance that the financial system remains sturdy,” Mulberry stated. “However, the longer interest rates remain elevated, the more stress they could induce.”