With interest rates at their highest levels in over two decades and inflation continuing to pressure consumers, major banks are bracing for increased risks associated with their lending activities.
During the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all reported an increase in their provisions for credit losses compared to the previous quarter. These provisions are funds set aside by banks to cover potential losses from bad debts and other lending risks, particularly concerning commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowances reached $21.8 billion at the end of the quarter, representing a significant increase from the previous period, and Wells Fargo recorded $1.24 billion in provisions.
These accumulated reserves indicate that banks are preparing for a riskier lending environment, as both secured and unsecured loans may result in larger losses for some of the country’s largest financial institutions. A recent analysis by the New York Federal Reserve revealed that total household debt in the U.S. has reached $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
With credit card issuance and delinquency rates on the rise as Americans exhaust their pandemic-era savings, credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate market also remains in a vulnerable state.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the economic landscape is still recovering from the effects of COVID-19, particularly regarding consumer finances, which have been supported by government stimulus.
However, potential challenges for banks are anticipated in the months ahead.
Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, explained that the provisions reported at a given quarter do not necessarily indicate recent credit quality, but rather, they represent banks’ expectations for future trends in defaults and delinquencies.
Currently, banks foresee a slowdown in economic growth, an increase in unemployment, and potential interest rate cuts later this year, which could lead to a higher number of defaults before the year concludes.
Citigroup’s chief financial officer, Mark Mason, highlighted that the warning signs appear to be particularly pronounced among lower-income consumers, who have seen their savings diminish since the pandemic began.
Mason noted that while the overall U.S. consumer remains resilient, there is a noticeable disparity in financial performance across different income levels. Only the top income quartile has managed to increase savings since early 2019, with customers boasting FICO scores above 740 driving spending growth and maintaining high payment rates. Conversely, those in lower FICO bands are experiencing a sharper decline in payment rates and are borrowing more due to the pressures of high inflation and interest rates.
The Federal Reserve has maintained its interest rates at a range of 5.25% to 5.5%, the highest level in 23 years, pending stabilization of inflation towards its 2% target before implementing the anticipated rate cuts.
Despite banks preparing for increased defaults later in the year, Mulberry pointed out that current default rates do not yet indicate a consumer crisis. He noted a divergence in experiences between homeowners and renters during the pandemic, as those who secured low fixed-rate mortgages are less affected by rising interest rates compared to renters facing surging housing costs.
Data shows that rent prices increased by more than 30% nationwide from 2019 to 2023, with grocery prices rising 25% during the same period. Renters, who missed out on locking in low rates, are now facing significant stress due to rising living costs that are outpacing wage growth.
For now, the key takeaway from the latest earnings reports is that there have been no significant new developments regarding asset quality. The banking sector continues to show strong revenues, profits, and net interest income, indicating its resilience.
Mulberry concluded that while the banking sector displays strength, ongoing high interest rates could continue to exert stress on the system.