As interest rates reach over two-decade highs and inflation puts pressure on consumers, major banks are bracing themselves for increased risks associated with their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions are intended to cover potential losses from credit risks, which include delinquent debts and loans, particularly in the commercial real estate sector.
JPMorgan set aside $3.05 billion for credit losses during the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses stood at $21.8 billion, more than tripling from the prior quarter, and Wells Fargo’s provisions totaled $1.24 billion.
These increased reserves indicate that banks are preparing for a tougher economic landscape, where both secured and unsecured loans could lead to more significant losses. The New York Fed recently reported that American households owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, credit card issuance is rising, and so are delinquency rates, as many consumers exhaust their pandemic savings and increasingly turn to credit. As of the first quarter of this year, total credit card balances hit $1.02 trillion, marking the second consecutive quarter that totals surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate market also remains under pressure.
“We’re still in the aftermath of the COVID-19 pandemic, and the banking sector’s health is influenced by the extensive stimulus that consumers received,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Any difficulties facing banks, however, may emerge over the coming months. Mark Narron, a senior director at Fitch Ratings, noted that provisions for credit losses reflect banks’ expectations about future credit quality rather than just recent trends.
Interestingly, there has been a shift from a model where provisions increase after loans start to perform poorly to one where macroeconomic factors influence provisioning decisions.
Looking ahead, banks predict slower economic growth, a rise in unemployment, and possibly two interest rate cuts later this year, in September and December. This scenario could lead to more delinquencies and defaults as the year comes to a close.
Citigroup’s CFO, Mark Mason, emphasized that these warning signs primarily affect lower-income consumers, who have seen their savings diminish since the pandemic. “While the U.S. consumer remains resilient overall, we are witnessing differing performances based on FICO scores and income levels,” he stated during a recent earnings call.
Mason noted that only the top income quartile has increased their savings compared to early 2019, with consumers with FICO scores over 740 driving spending growth and maintaining high payment rates. Conversely, those with lower FICO scores are experiencing a decline in payment rates and are borrowing more due to the strain of high inflation and interest rates.
Currently, the Federal Reserve is maintaining interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation metrics towards its 2% target before considering anticipated rate cuts.
Despite banks gearing up for a potential increase in defaults in the latter half of the year, Mulberry observes that defaults are not yet escalating at a level indicative of a consumer crisis. He is particularly monitoring the division between homeowners and renters since the pandemic.
Although interest rates have risen significantly, homeowners have secured low fixed rates on their debts and thus are not feeling the financial squeeze as much. In contrast, renters who couldn’t lock in these rates are facing substantial stress, with rents rising over 30% nationally from 2019 to 2023 and grocery prices increasing by 25% during the same timeframe.
Overall, the recent earnings reports indicate stability in asset quality, with strong revenues, profits, and net interest income being positive signs for the banking sector. Narron pointed out that the banking system remains robust and sound. “There’s strength in the banking sector that is reassuring, but we must keep a close watch as prolonged high interest rates can create additional stress,” Mulberry added.