With interest rates reaching levels not seen in over 20 years and inflation continuing to pressure consumers, major banks are positioning themselves to tackle increasing risks associated with their lending activities.
In the second quarter of this year, 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 potential losses from credit risk, including bad debt and loans related to commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses rose to $21.8 billion by the end of the quarter, significantly more than the previous quarter’s reserves, and Wells Fargo reported provisions of $1.24 billion.
These provisions indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans might lead to larger losses. A recent analysis by the New York Federal Reserve revealed that American consumers collectively owe $17.7 trillion across various debts, including consumer and student loans as well as mortgages.
Additionally, credit card issuance is climbing, with delinquency rates also on the rise as individuals deplete their pandemic-era savings and increasingly rely on credit. In the first quarter of this year alone, credit card balances surpassed $1.02 trillion for the second consecutive quarter, according to data from TransUnion. The commercial real estate sector remains particularly vulnerable.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking industry is still navigating the aftermath of the COVID-19 pandemic, largely influenced by stimulus measures previously provided to consumers.
Experts suggest that any banking issues are likely to arise in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that current provisions are more indicative of anticipated future credit quality rather than reflecting past performance.
Narron anticipates that banks will face slowing economic growth and a rising unemployment rate, along with projected interest rate cuts later this year, which might lead to increased delinquencies and defaults before the year concludes.
Citigroup’s CFO Mark Mason highlighted concerns particularly among lower-income consumers, whose savings have diminished post-pandemic. He noted that while the overall U.S. consumer appears resilient, there is a notable disparity in financial health across different income brackets.
Mason stated that only the highest income quartile has maintained more savings than before the pandemic, with customers holding a FICO score above 740 seeing growth in spending and consistent payment rates. In contrast, those with lower FICO scores are struggling with payment rates declining as they face inflation and high interest rates more acutely.
The Federal Reserve has maintained interest rates at a 23-year high, between 5.25% and 5.5%, waiting for inflation to stabilize closer to its target of 2% before implementing the anticipated rate cuts.
Despite the banks’ preparations for potential defaults later in the year, Mulberry noted that the current default rates do not indicate an impending consumer crisis. He is particularly monitoring the divide between homeowners, who generally locked in low fixed rates, and renters, who have faced a dramatic rise in rental prices.
Between 2019 and 2023, rents increased over 30%, and grocery costs rose by 25%, creating significant financial stress for renters compared to those who secured low mortgage rates during the pandemic.
Ultimately, analysts pointed out that recent earnings reports did not suggest any new issues with asset quality. Robust revenues, profits, and healthy net interest income indicate a resilient banking sector. The stability of the financial system is seen as a positive sign, though analysts emphasize the need for vigilance as prolonged high interest rates could induce further stress in the future.