As interest rates remain at their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all raised their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks reserve to cover potential losses from credit risks, including delinquent loans and bad debts.
JPMorgan set aside $3.05 billion for credit losses during the second quarter, while Bank of America earmarked $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, more than tripling its reserves from the prior quarter. Wells Fargo also increased its provisions to $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier environment, as both secured and unsecured loans could lead to greater losses. A recent analysis by the New York Federal Reserve revealed that Americans now owe a collective total of $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, the issuance of credit cards is rising, accompanied by increasing delinquency rates, as individuals exhaust their savings accumulated during the pandemic and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter in which total cardholder balances exceeded the trillion-dollar threshold, according to TransUnion. The commercial real estate sector is also facing significant uncertainties.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted, “We’re still coming out of this COVID era, and largely due to the stimulus measures implemented for consumers.”
However, challenges for banks are anticipated in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported in any given quarter don’t solely reflect recent credit quality, but rather what banks predict will occur in the future.
“As we transition from a historical system where provisions increased with bad loans, we now see that macroeconomic forecasts drive provisioning,” Narron added.
In the near term, banks are forecasting sluggish economic growth, a rise in unemployment, and two interest rate cuts later this year, which may lead to more delinquencies and defaults as the year draws to a close.
Citi’s chief financial officer, Mark Mason, pointed out that the signs of concern are primarily among low-income consumers, whose savings have diminished since the pandemic began.
“While the broader U.S. consumer remains resilient, we are witnessing a performance divergence based on income levels and credit scores,” Mason indicated during a recent analyst call.
He highlighted that only the highest income group has more savings compared to early 2019, with customers boasting high FICO scores driving spending growth and maintaining repayment rates. Conversely, customers with lower FICO scores are struggling more, borrowing more heavily and facing declines in payment rates due to high inflation and interest rates.
The Federal Reserve has held interest rates steady at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation measures towards its 2% target before implementing anticipated rate cuts.
Despite banks preparing for higher default rates later in the year, Mulberry observes that defaults are not currently rising at a pace indicative of a consumer crisis. He emphasizes the distinction between experiences of homeowners and renters during the pandemic.
“While rates have increased significantly, homeowners benefited from locking in low fixed rates on their debts and are not feeling the financial strain as acutely,” he stated. In contrast, renters have had to contend with rising rental costs and grocery prices, with rents increasing over 30% nationwide since 2019 while grocery costs have risen by 25%, straining their monthly budgets.
At this stage, the key takeaway from the recent earnings reports is that there have not been significant changes in asset quality, Narron noted. Strong revenues, profits, and robust net interest income all point to a still-healthy banking sector.
“There’s strength in the banking sector that may not have been entirely unexpected, but it is reassuring to recognize that the financial system structures remain robust at this time,” Mulberry remarked. “However, we will be closely monitoring the situation; prolonged high interest rates will increase pressure on the system.”