As interest rates remain at their highest levels in over two decades and inflation continues to affect consumers, major banks are preparing for potential heightened risks in their lending practices.
In the second quarter, banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the prior quarter. These provisions are funds that financial institutions set aside to cushion against possible losses from credit risks, which may include delinquent debts and problematic lending, particularly in commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s total for credit loss provisions reached $21.8 billion, marking a significant increase from previous quarters; and Wells Fargo’s provisions amounted to $1.24 billion.
These heightened reserves indicate that banks are bracing for a riskier lending environment, where both secured and unsecured loans could lead to increased losses. A recent analysis by the New York Federal Reserve revealed that American households now owe a collective total of $17.7 trillion in consumer, student, and mortgage loans.
Additionally, credit card issuance is rising, with delinquencies also on the uptick as many individuals exhaust savings accrued during the pandemic and increasingly depend on credit. In the first quarter of this year, credit card balances exceeded $1 trillion for the second consecutive quarter, as reported by TransUnion. The commercial real estate sector continues to face challenges as well.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, this is still a recovery phase post-COVID, greatly influenced by the stimulus provided to consumers.
However, the challenges for banks are anticipated to manifest more significantly in the upcoming months.
Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that the provisions noted in any quarter are not necessarily indicative of recent credit quality but instead reflect banks’ future expectations.
Narron mentioned that the current environment has shifted towards a system where macroeconomic forecasts largely dictate provisioning levels rather than past loan performance.
Banks are currently forecasting slower economic growth, an increase in unemployment rates, and potential interest rate cuts in September and December, which may lead to more delinquencies and defaults by year-end.
Citigroup’s CFO Mark Mason pointed out that the issues appear to be more pronounced among lower-income consumers, who have seen their savings diminish in the wake of the pandemic.
While the overall U.S. consumer remains resilient, there is a clear divergence in financial performance across different FICO scores and income levels, Mason noted. Only consumers in the highest income quartile have accumulated more savings since 2019, with those scoring above 740 on the FICO scale driving spending growth and maintaining high payment rates. In contrast, those in lower FICO brackets are facing declines in payment rates and increasing debt loads, largely due to the effects of inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of between 5.25% and 5.5%, waiting for inflation to stabilize around its 2% target before proceeding with planned rate cuts.
Despite bankers preparing for potential defaults later in the year, Mulberry emphasized that defaults have not surged to a level indicating a consumer crisis. He is particularly focused on the differences between homeowners who benefited from low fixed rates during the pandemic and renters who did not have that opportunity.
While interest rates have increased significantly, those who locked in low mortgage rates are largely insulated from financial strain, unlike renters who are facing rising rental costs and limited wage growth.
For the moment, the latest earnings reports suggest stability within the banking sector, with no significant changes in asset quality noted. Strong revenues, profits, and net interest income reflect a resilient banking environment.
Mulberry concluded that while some strength remains in the banking sector, ongoing high-interest rates are likely to introduce more stress in the future.