As interest rates reach their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for potential challenges stemming from their lending activities.
In the second quarter, prominent banks including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions are funds that banks reserve to mitigate potential losses from credit risks, such as delinquent loans and bad debts, particularly in commercial real estate.
JPMorgan set aside $3.05 billion for credit losses in the second quarter; Bank of America allocated $1.5 billion; Citigroup’s credit loss allowance at the end of the quarter reached $21.8 billion, significantly up from its previous reserves; and Wells Fargo accounted for $1.24 billion.
This buildup illustrates that banks are preparing for a more uncertain environment where both secured and unsecured loans could lead to greater losses for these financial institutions. According to an analysis from the New York Federal Reserve, Americans currently carry a staggering $17.7 trillion in combined consumer loans, student debt, and mortgages.
The rise in credit card issuance and delinquency rates is also evident, as individuals increasingly rely on credit due to depleting savings from the pandemic era. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total balances surpassed the trillion-dollar threshold, according to TransUnion. Additionally, the commercial real estate sector remains in a vulnerable state.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, pointed out that the banking sector is still recovering from the COVID-19 period, largely due to the stimulus measures that were provided to consumers.
However, experts believe that the true effects on banks will materialize in the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, noted that the provisions recorded in any given quarter do not directly correlate to the credit quality observed in the past three months, but rather reflect banks’ expectations for the future.
He added that the landscape has shifted from a system where increased defaults traditionally drove up provisions to one where macroeconomic outlooks heavily influence provisioning strategies.
Looking ahead, banks anticipate a slowdown in economic growth, an increase in unemployment, and expected interest rate cuts later in the year. This scenario could lead to a rise in delinquencies and defaults as the year comes to a close.
Citi’s chief financial officer Mark Mason highlighted that these potential issues are particularly pronounced among lower-income consumers who have experienced a decline in savings since the pandemic.
“While we continue to see an overall resilient U.S. consumer, it is important to note the divergence in financial performance and behavior across different income levels,” Mason remarked during a recent analysts’ call. He pointed out that only the highest income quartile has more savings than before 2019 and those with higher credit scores are driving spending growth while lower credit score customers face more significant challenges.
The Federal Reserve currently maintains interest rates at a 23-year high of 5.25-5.5%, holding off on cuts until inflation shows signs of stabilizing towards its 2% target.
Despite the banks’ preparations for increasing defaults later in the year, analysts do not yet see a drastic rise in defaults that would indicate a consumer crisis. Mulberry indicated the need to monitor the differences between homeowners and renters from the pandemic era. Homeowners haven’t felt as much financial strain due to locking in low fixed-rate mortgages, while renters, facing a more than 30% increase in rent and a 25% rise in grocery costs since 2019, are experiencing the most financial pressure.
For now, the consensus from recent earnings reports suggests stability in asset quality. “Strong revenues, profits, and robust net interest income are indicative of a healthy banking sector,” Narron stated. Mulberry echoed this sentiment, noting the strength of the financial system while cautioning that prolonged high interest rates could introduce further stress in the future.