As interest rates reach over two-decade highs and inflation continues to affect consumers, major banks are bracing for increased risks associated with their lending operations.
In the second quarter of the year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all elevated their provisions for credit losses compared to the previous quarter. These provisions are funds that banks allocate to manage potential losses from credit risks, including delinquent loans and commercial real estate (CRE) lending.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses amounted to $21.8 billion by the quarter’s end, significantly more than the previous quarter, and Wells Fargo reported provisions totaling $1.24 billion.
These increased provisions reflect banks preparing for a challenging environment where both secured and unsecured loans may lead to significant losses. According to a recent analysis by the New York Fed, American households owe approximately $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, credit card issuance and delinquency rates are climbing as people’s savings from the pandemic era diminish, leading them to rely more heavily on credit. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where total balances surpassed the trillion-dollar threshold, as reported by TransUnion. The commercial real estate sector also remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the lingering effects of the COVID-19 pandemic, particularly regarding consumer health and banking, attributing much of the current financial landscape to the stimulus measures introduced during the pandemic.
However, banks are anticipating challenges in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, emphasized that current provisions do not necessarily reflect recent credit quality but instead forecast what banks expect to occur in the future.
In the near future, banks are predicting slower economic growth, increased unemployment rates, and two anticipated interest rate cuts later this year in September and December. This outlook may result in higher delinquencies and defaults as the year concludes.
Mark Mason, chief financial officer of Citi, pointed out that these warning signs are particularly centered on lower-income consumers who have seen their savings diminish since the pandemic. He observed that while the overall U.S. consumer remains resilient, there is a noticeable divergence in behavior across different income levels and credit scores.
Mason noted that only the highest income quartile has more savings than at the start of 2019, with customers having a FICO score above 740 driving spending growth and maintaining high payment rates. In contrast, customers in lower FICO bands are experiencing declines in payment rates and increased borrowing, attributing this to the pressures of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% while awaiting stabilization of inflation towards its 2% target before implementing expected rate cuts.
Despite banks preparing for potential defaults in the latter half of the year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He is observing the differences in financial experiences between homeowners and renters during this period.
While homeownership rates have risen, with many locking in low fixed mortgage rates, renters have faced over a 30% increase in rent since 2019, alongside a 25% rise in grocery prices. This has created significant strain on renters’ budgets, who do not have the advantage of low fixed rates.
Currently, the key takeaway from the latest earnings reports is that asset quality remains stable, with robust revenues, profits, and resilient net interest income suggesting the banking sector is still healthy. Mulberry remarked on the strength of the financial system, but cautioned that prolonged high interest rates could lead to increased stress within the sector.