As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are preparing for increased risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all augmented their provisions for credit losses compared to the previous quarter. These provisions are reserves set aside by banks to cover potential losses from credit risk, which includes overdue debts and troubled lending, particularly in commercial real estate (CRE).
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 climbed significantly to $21.8 billion, more than tripling its reserve build since the last quarter, and Wells Fargo recorded provisions of $1.24 billion.
These increased reserves indicate that banks are anticipating a riskier lending landscape, where both secured and unsecured loans may lead to higher losses. A recent analysis by the New York Federal Reserve revealed that U.S. households owe a total of $17.7 trillion across various consumer debts, including loans and mortgages.
Additionally, credit card issuance and delinquency rates are on the rise as consumers deplete their pandemic-era savings and increasingly depend on credit. The total amount of credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the situation, highlighting the effects of stimulus measures deployed during the COVID-19 pandemic on consumer banking health.
However, he cautions that any issues for banks may materialize in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that the provisions reported by banks do not solely reflect recent credit quality but rather their expectations for future trends.
He noted that the banking sector has shifted from a historical approach, where increased loan defaults prompt higher provisions, to a system where macroeconomic forecasts dictate provisioning strategies.
In the near term, banks are bracing for slower economic growth, an uptick in unemployment, and potential interest rate cuts later this year. This could predictably lead to more delinquencies and defaults by year-end.
Citigroup Chief Financial Officer Mark Mason highlighted that concerns are focused on lower-income consumers, who have been depleting their savings since the pandemic.
Despite the resilience seen in the overall U.S. consumer market, Mason pointed out a divergence in performance based on income and credit scores. Only high-income groups have managed to save more since early 2019, while households with lower credit scores are experiencing declines in payment rates and increased borrowing, both exacerbated by high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation metrics toward its 2% target before implementing expected rate cuts.
While banks are gearing up for possible increased defaults later this year, current default rates do not indicate an imminent consumer crisis, according to Mulberry. He is particularly attentive to the differences between homeowners and renters during this transitional period.
Despite significant increases in interest rates, homeowners secured low fixed-rate mortgages, so many are not yet feeling the financial strain. In contrast, renters, who have witnessed rental rates soar more than 30% since 2019, face significant monthly budget pressures compounded by increasing grocery costs.
Overall, analysts find that the latest earnings reports indicate solid asset quality within the banking sector. Strong revenues, profits, and net interest income remain positive signs for the health of the banking industry.
Mulberry concluded that while certain strengths in the banking sector may not be entirely unexpected, it is crucial to monitor the situation closely. Prolonged high interest rates could lead to increased financial stress in the future.