As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are preparing for increased risks related to their lending activities.
In the second quarter, leading banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their provisions for credit losses compared to the previous quarter. These provisions are funds set aside by financial institutions to cover potential losses from credit risks, including delinquent debts and loans, notably in the area of commercial real estate.
JPMorgan allocated $3.05 billion for credit loss provisions in the last quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses surged to $21.8 billion by the end of the quarter, more than tripling its previous reserve. Additionally, Wells Fargo reported provisions totaling $1.24 billion.
These increased provisions indicate that banks are bracing for a more challenging lending environment, where both secured and unsecured loans may lead to greater losses. A recent report from the New York Fed highlighted that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Furthermore, the issuance of credit cards and rising delinquency rates are concerning as consumers deplete their pandemic-era savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also remains vulnerable.
Brian Mulberry, a portfolio manager at Zacks Investment Management, remarked on the lingering effects of the COVID era, particularly in regards to banking and consumer financial health influenced by previous stimulus measures.
Looking ahead, experts warn that any issues for banks may surface in the coming months. Mark Narron, a senior director at Fitch Ratings, pointed out that the provisions reported in any quarter may not accurately reflect credit quality but rather signify banks’ expectations for future developments.
Currently, banks anticipate slowing economic growth, increased unemployment rates, and a likelihood of two interest rate cuts later this year in September and December. This outlook raises concerns about potential delinquencies and defaults as the year progresses.
Citigroup’s chief financial officer Mark Mason noted that the emerging challenges appear more pronounced among lower-income consumers whose savings have diminished since the pandemic. He stated that while the overall U.S. consumer remains resilient, there is a stark divergence in financial behaviors across various income levels and credit scores.
According to Mason, only the highest income quartile has managed to increase its savings since early 2019, while customers with credit scores above 740 contribute most to spending growth and maintain higher payment rates. In contrast, lower credit score individuals are experiencing a decline in payment rates and have begun borrowing more due 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%, awaiting stabilization of inflation rates towards the central bank’s target of 2% before considering anticipated rate cuts.
Despite banks preparing for an increase in defaults later in the year, Mulberry believes that current default rates do not indicate a looming consumer crisis. He is particularly focused on the differentiation between homeowners and renters from the pandemic period.
While interest rates have indeed increased significantly, homeowners who secured low fixed rates on their mortgage debt are not feeling the impact as acutely. Conversely, renters, who did not have the opportunity to secure low rates, are grappling with rental prices that have surged over the past few years, which have outpaced wage growth.
For the moment, the latest earnings reports reveal no alarming trends in asset quality. Strong revenues, profits, and stable net interest income suggest a robust banking sector. Mulberry concluded that while there are signs of strength, long-term high-interest rates could lead to increased pressure on consumers and banks alike.