As interest rates reach levels not seen in over 20 years and inflation continues to pressure consumers, major banks are bracing for increased risks associated with their lending activities.
In the second quarter, leading banks including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their provisions for credit losses compared to the previous quarter. These provisions serve as a financial cushion for potential losses stemming from credit risk, which includes bad debt and issues related to lending, particularly in commercial real estate.
Specifically, JPMorgan allocated $3.05 billion for credit losses in the second quarter, Bank of America set aside $1.5 billion, Citigroup’s credit loss allowance surged to $21.8 billion – more than tripling its reserve build from the prior quarter – and Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging financial environment where both secured and unsecured loans could lead to significant losses. A recent report from the New York Federal Reserve highlighted that Americans owe a staggering $17.7 trillion across consumer loans, student loans, and mortgages.
Moreover, credit card issuance is on the rise, along with delinquency rates, as many consumers are depleting their savings accumulated during the pandemic and increasingly depending on credit. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter of exceeding the trillion-dollar threshold. The commercial real estate sector also remains vulnerable.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the ongoing recovery from the COVID-19 pandemic, particularly regarding consumer banking health, is influenced by the stimulus measures that were previously deployed.
Problems for banks, however, may not be immediate. Mark Narron, a senior director at Fitch Ratings, noted that the provisions reported in any quarter do not necessarily reflect the recent past, but rather what banks anticipate in the near future.
“A shift has occurred where the macroeconomic outlook is becoming the primary driver for provisioning,” Narron explained. The banks currently predict slower economic growth, a rise in unemployment, and two anticipated interest rate cuts in September and December, which could lead to increased delinquencies and defaults by year-end.
Citi’s CFO Mark Mason emphasized that concerns seem more pronounced among lower-income consumers, who have seen their savings diminish since the pandemic’s onset. He remarked that while overall U.S. consumer strength appears resilient, a disparity exists based on income and credit scores.
Specifically, Mason noted that only the highest income quartile has increased savings since early 2019, with consumers boasting higher credit scores being responsible for spending growth and maintaining consistent payment rates. Conversely, those with lower credit scores are experiencing greater financial strain, illustrated by rising borrowing and declining payment rates as they struggle with inflation and high interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation before proceeding with anticipated rate cuts.
Despite the uptick in defaults predicted for the latter part of the year, Mulberry suggests that they have not yet reached levels indicative of a consumer crisis. He is particularly interested in differentiating between homeowners and renters in regards to their financial stress.
While interest rates have increased significantly, homeowners generally secured low fixed rates on their mortgages during the pandemic, insulating them from immediate financial discomfort. In contrast, renters, who have seen rental prices rise more than 30% nationwide since 2019 and grocery costs increase by 25%, face tighter budgets due to escalating costs outpacing wage growth.
Ultimately, the recent earnings reports indicate no significant changes in asset quality, according to Narron. The banking sector continues to demonstrate strong revenues, profitability, and net interest income, signaling its resilience.
“There remains a notable strength in the banking sector, which is not entirely surprising but certainly reassuring regarding the robustness of the financial system,” Mulberry stated. However, he cautioned that prolonged high interest rates could lead to increased stress in the future.