With interest rates at their highest in over 20 years and inflation continuing to burden consumers, major banks are preparing for increased risks associated with their lending activities.
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 that banks set aside to cover potential losses from credit risks, including defaults and delinquent debts.
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s allowance for credit losses reached $21.8 billion, significantly more than its previous quarter; and Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier lending environment, where both secured and unsecured loans may lead to larger losses. A recent report from the New York Fed revealed that American households have a combined $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also climbing as individuals use their pandemic savings and turn to credit. In the first quarter of this year, credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. Additionally, the commercial real estate sector faces uncertain challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, stated, “We’re still coming out of this COVID era, and mainly when it comes to banking and the health of the consumer, it was all of the stimulus that was deployed to the consumer.”
However, potential challenges for banks may emerge in the coming months.
According to Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, the provisions reported in any given quarter do not directly reflect recent credit quality but rather banks’ expectations for future conditions.
He explained, “We’ve transitioned from a system where increasing bad loans would drive up provisions to one where macroeconomic forecasts primarily influence provisioning.”
In the near future, banks are forecasting slower economic growth, a rise in unemployment, and two anticipated interest rate cuts later this year. This situation could lead to more delinquencies and defaults as the year concludes.
Citi CFO Mark Mason highlighted that red flags are primarily concentrated among lower-income consumers, who have seen their savings decline since the pandemic.
“While we continue to see an overall resilient U.S. consumer, we also observe a divergence in performance and behavior across FICO and income bands,” Mason noted in a call with analysts.
He added, “Only the highest income quartile has more savings than at the start of 2019, with high FICO score customers driving spending growth and maintaining elevated payment rates. In contrast, lower FICO band customers are experiencing significant drops in payment rates and are borrowing more due to the adverse impact of high inflation and interest rates.”
The Federal Reserve has maintained interest rates at a peak of 5.25-5.5% as it waits for inflation to stabilize toward its 2% target before conducting anticipated rate cuts.
Despite banks preparing for potential increased defaults later in the year, current default rates do not yet indicate a consumer crisis, according to Mulberry. He is particularly observing the differences between homeowners during the pandemic and renters.
While interest rates have spiked, homeowners were able to secure low fixed rates on their debts, meaning they are less affected financially. However, renters, who have faced over a 30% rise in rents since 2019 and 25% increases in grocery costs, are feeling the most financial strain, as their rental expenses have outpaced wage growth.
Currently, the key takeaway from recent earnings reports is that “there was nothing new this quarter in terms of asset quality,” Narron pointed out. Robust revenues, profits, and stable net interest income are encouraging signs for the overall health of the banking sector.
Mulberry further stated, “There is some resilience in the banking sector, and while it was not completely unexpected, it is reassuring to see that the financial system remains strong. However, we are closely monitoring the situation as prolonged high interest rates can lead to increased stress.”