As interest rates reach their highest levels in over twenty years and inflation continues to impact consumers, major banks are bracing for increased risks in their lending operations.
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 amounts reserved by banks to address potential losses from credit risks, such as unpaid debts and loans, particularly in commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses during the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses rose sharply to $21.8 billion, significantly increasing its reserves from the prior quarter. Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves reflect banks’ vigilance in anticipating a more challenging environment for both secured and unsecured loans, which could potentially lead to larger losses. A recent report by the New York Federal Reserve indicated that American households collectively owe $17.7 trillion across various forms of consumer debt, including student and mortgage loans.
Credit card issuance has surged, accompanied by rising delinquency rates as many consumers deplete their savings accumulated during the pandemic and increasingly turn to credit. According to TransUnion, credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where balances surpassed the trillion-dollar threshold. The commercial real estate sector also remains under significant pressure.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, pointed out that the economy is still recovering from the effects of COVID-19, which was initially supported by substantial stimulus efforts.
However, challenges for banks are likely to materialize in the coming months. Mark Narron, a senior director with Fitch Ratings, explained that the provisions set aside each quarter do not directly correlate with recent credit quality but rather indicate banks’ future expectations.
Banks are predicting slower economic growth, rising unemployment, and potential interest rate cuts later in the year, which could lead to more delinquencies and defaults.
Citi’s CFO Mark Mason highlighted that the concerns appear to be most pronounced among lower-income consumers, who have seen their savings diminish since the pandemic began.
Although the broader U.S. consumer remains resilient, there is a noticeable disparity in financial health across different income brackets. Mason noted that only the highest income quartile has managed to increase their savings since early 2019, with higher FICO score customers driving spending growth and maintaining solid payment rates. In contrast, those in lower FICO brackets are experiencing significant declines in payment rates and are borrowing more heavily due to the combined pressures of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25% to 5.5%, awaiting stabilization in inflation before considering rate cuts.
Despite banks’ preparations for a rise in defaults, it has not yet reached a level that indicates an impending consumer crisis, according to Mulberry. He is particularly observing the differences between homeowners and renters from the pandemic era.
While homeownership may pose less immediate financial strain due to locked-in low fixed-rate mortgages, renters have not had that opportunity and are facing challenges from rising rents, which have increased by over 30% nationwide since 2019, alongside a 25% rise in grocery costs.
Overall, the latest earnings reports suggest stability in the banking sector, with no alarming changes in asset quality. Strong revenues, profits, and robust net interest income indicate that the banking industry remains healthy. However, continuous monitoring is essential, as prolonged high interest rates could introduce more stress into the financial system.