Amidst interest rates at highs not seen in two decades and persistent inflation pressures on consumers, major banks are preparing for increased risks linked to 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 the capital that banks set aside to cover potential losses arising from credit risks, including problems related to delinquency and bad debts, particularly concerning commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses during the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s credit loss reserves hit $21.8 billion by the end of the quarter, more than tripling its provision from the previous quarter. Wells Fargo reported provisions totaling $1.24 billion.
This increase in reserves indicates that banks are preparing for a riskier environment where both secured and unsecured loans could lead to significant losses. A recent report by the New York Federal Reserve showed that American households carry a staggering $17.7 trillion in debt across consumer loans, student loans, and mortgages.
Credit card issuance, alongside rising delinquency rates, is also becoming problematic as individuals deplete their pandemic-era savings and increasingly rely on credit. Credit card balances surpassed $1 trillion in the first quarter, marking the second consecutive quarter where totals exceeded this threshold, according to TransUnion. Meanwhile, the commercial real estate sector remains under scrutiny.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, highlighted the lingering effects of the COVID era on both banking and consumer health, linking these issues to the extensive stimulus measures provided to consumers.
Challenges for banks, however, are anticipated in the upcoming months. Mark Narron, a senior director at Fitch Ratings, pointed out that the provisions reported in any quarter do not necessarily reflect credit quality for that quarter but instead indicate banks’ expectations of future conditions.
Looking ahead, banks expect slower economic growth, a rise in unemployment, and potential interest rate cuts later this year, which may lead to increased delinquencies and defaults as 2023 comes to a close.
Citi’s chief financial officer, Mark Mason, noted that warning signs are particularly evident among lower-income consumers, who have seen their savings diminish since the pandemic began. He highlighted a growing divide in consumer behavior based on income and credit scores.
Mason explained that only consumers in the highest income bracket have more savings than they did in early 2019, with high-FICO score clients driving spending growth while lower-FICO score customers face declining payment rates and borrowed more due to financial pressures from high inflation and interest rates.
The Federal Reserve continues to maintain interest rates within a range of 5.25-5.5%, the highest in 23 years, as they monitor for stability in inflation measures aligned with their 2% target before proceeding with anticipated rate cuts.
Despite banks bracing for an uptick in defaults, Mulberry pointed out that consumer defaults have not yet escalated to concerning levels, suggesting a more complex scenario whereby homeowners, who secured low fixed rates during the pandemic, are less affected than renters facing increasing costs.
With rents rising over 30% nationwide since 2019 and grocery prices climbing 25%, renters, who did not benefit from fixed-rate mortgages, are experiencing significant financial strain, according to Mulberry.
Currently, the overarching insight from the latest earnings reports indicates that there are no alarming new trends in asset quality. Strong revenue figures, profits, and robust net interest income signify a still-healthy banking sector.
Mulberry expressed cautious optimism, stating that while the banking system remains fundamentally sound, prolonged periods of high interest rates are likely to induce more stress in the future.