Amidst interest rates hitting their highest levels in over 20 years and ongoing inflation pressures on consumers, major banks are preparing for potential risks associated with their lending practices.
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 are funds that banks set aside to cover possible losses from credit risks, such as delinquencies or bad debts, particularly in the commercial real estate (CRE) sector.
JPMorgan allocated $3.05 billion for credit losses during the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the quarter’s end, which more than tripled its reserves from the previous quarter. Wells Fargo provided $1.24 billion for credit losses.
The increase in these reserves indicates that banks are bracing for a riskier lending environment where both secured and unsecured loans may lead to greater losses. Recent analysis by the New York Fed highlights that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, credit card issuance and delinquency rates are rising as people exhaust their savings accumulated during the pandemic and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter, marking the second consecutive quarter surpassing the trillion-dollar milestone, according to TransUnion. The CRE sector, in particular, remains under scrutiny.
Experts note that the banking sector is still responding to the impacts of the COVID era, primarily shaped by government stimulus efforts aimed at consumers. However, challenges for banks are anticipated in the coming months.
According to Mark Narron from Fitch Ratings, provisions reported in any quarter reflect banks’ expectations of future credit quality rather than just recent performance, indicating a shift in how banks approach risk management.
In the short term, banks expects slowing economic growth, rising unemployment rates, and potential interest rate cuts later this year, which may lead to increasing delinquencies and defaults as the year draws to a close.
Citi’s CFO Mark Mason highlighted concerning trends among lower-income consumers who have seen their savings diminish since the pandemic began. While the overall U.S. consumer remains resilient, there’s a noticeable gap in performance based on income levels and credit scores.
Currently, only the highest income quartile has more savings than they did at the beginning of 2019, and customers with FICO scores over 740 are primarily driving spending growth and maintaining payment levels. In contrast, lower-income consumers are experiencing greater difficulty, facing rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a two-decade high of 5.25-5.5% and is holding off on rate cuts until inflation stabilizes closer to its 2% target.
Although banks anticipate potential defaults to increase later this year, Mulberry from Zacks Investment Management indicates that defaults have not yet reached alarming levels. He is particularly observing the differences in financial stability between homeowners and renters during this period.
While rates have substantially risen, homeowners typically locked in low fixed rates during the pandemic, mitigating their current financial pain. Conversely, renters, who did not have that opportunity, are struggling with rising rental costs, which have surged over 30% nationwide since 2019, as well as grocery prices, which increased by 25% in the same timeframe.
Despite these challenges, the latest earnings reports from banks suggest there are no new issues regarding asset quality. Strong revenues and profits signal that the banking sector remains healthy.
Narron notes that the ongoing strength in the banking sector is reassuring, but the longer interest rates remain at high levels, the more pressure it will exert on consumers and the overall financial system.