As interest rates are at their highest in over two decades and inflation continues to impact consumers, major banks are bracing themselves for potential increased risks associated with 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 set aside by financial institutions to cover potential losses from credit risks, including delinquent loans and commercial real estate (CRE) loans.
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 end of the quarter, more than tripling its reserves from the previous quarter. Wells Fargo recorded provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans could result in greater losses for some of the largest banking institutions in the country. A recent analysis by the New York Federal Reserve found that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as consumers increasingly rely on credit due to diminishing pandemic-era savings. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter where the total exceeded one trillion dollars, according to TransUnion. The commercial real estate sector also remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, stated that the ongoing recovery from the COVID-19 pandemic has been significantly supported by government stimulus measures directed towards consumers.
However, any challenges facing banks are anticipated to materialize in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that the provisions recorded in any given quarter do not necessarily reflect the recent credit quality but rather indicate future expectations.
Narron emphasized a shift in banking dynamics, where macroeconomic forecasts now largely dictate provisioning practices, rather than simply reflecting past loan performance.
Looking ahead, banks are projecting an economic slowdown, higher unemployment rates, and potential interest rate cuts later this year. These factors could contribute to an increase in delinquencies and defaults as the year progresses.
Citigroup’s chief financial officer Mark Mason highlighted that emerging issues are particularly concentrated among lower-income consumers, who have experienced significant declines in their savings since the pandemic.
While the overall U.S. consumer remains resilient, Mason observed a disparity in financial health across various income and credit score brackets. Only the highest income quartile has managed to maintain greater savings compared to early 2019, and it is primarily those with credit scores above 740 who are driving spending growth and keeping up with payments. In contrast, individuals with lower credit scores are facing declining payment rates and increased borrowing due to high inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation toward the central bank’s 2% target before considering rate cuts.
Despite banks preparing for a potential uptick in defaults later in the year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He is particularly scrutinizing the differences between homeowners and renters from the pandemic period.
Although interest rates have significantly increased since then, Mulberry pointed out that homeowners locked in low fixed rates and are largely unaffected by the current climate. Conversely, renters, who could not benefit from these low rates, are experiencing financial strain due to rising rents.
From the latest earnings reports, the primary takeaway is that there were no major changes in asset quality for the quarter. Robust revenues, profits, and strong net interest income suggest that the banking sector continues to demonstrate resilience.
Mulberry expressed relief that the financial system remains robust, but warned that prolonged high interest rates could lead to increased stress within the banking sector.