With interest rates at their highest in over twenty years and inflation affecting consumers, major banks are bracing for increased risks associated with their lending operations.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their credit loss provisions compared to the previous quarter. These provisions represent the funds that financial institutions allocate to cover potential losses from credit risks, which include delinquent accounts and flawed loans, particularly in commercial real estate.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America contributed $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, marking a dramatic increase from the previous quarter, and Wells Fargo allocated $1.24 billion.
These provisions indicate that banks are preparing for a more challenging financial landscape in which both secured and unsecured loans may lead to greater losses. A recent analysis from the New York Fed found that total household debt in the U.S. has reached $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card usage and delinquency rates are also on the rise as people exhaust their pandemic-era savings and rely more on credit. In the first quarter of this year, credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. Meanwhile, commercial real estate remains in a vulnerable position.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking system and consumer health are still feeling the effects of pandemic-era stimulus measures.
Issues for banks could emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions do not solely reflect past credit quality but rather banks’ expectations for the future.
He noted a shift in the banking system, where macroeconomic forecasts are increasingly influencing provisioning practices rather than solely the performance of existing loans.
In the short term, banks anticipate a slowdown in economic growth, an increase in unemployment, and two interest rate cuts expected in September and December. This may lead to further delinquencies and defaults by year’s end.
Citi’s CFO, Mark Mason, highlighted that financial challenges are primarily affecting lower-income consumers, who have seen their savings diminish since the pandemic.
“Although the overall U.S. consumer remains resilient, we observe significant variations in performance and behavior across different income levels and credit score categories,” Mason noted during a recent analyst call. Only the highest income quartile has increased their savings since 2019, with those in the highest credit score range powering spending growth and maintaining high payment rates. Conversely, those with lower credit scores are experiencing sharper declines in payment rates and are borrowing more amid soaring inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25%-5.5%, awaiting stabilization in inflation toward its 2% target before proceeding with anticipated rate cuts.
Despite preparations for a potential rise in defaults later in the year, current trends do not yet indicate a consumer crisis, according to Mulberry. He is particularly interested in the divide between homeowners and renters during the pandemic.
“Although interest rates have risen significantly, homeowners benefitted from locking in lower fixed rates, which shields them from immediate financial strain,” Mulberry stated. In contrast, renters have faced housing costs that have surged over 30% since 2019, along with grocery prices climbing by 25%, heightening the financial pressure on those who could not secure low mortgage rates.
Currently, the overarching message from the latest earnings reports is a lack of new information regarding asset quality. Strong revenues, profits, and resilient net interest income continue to signify a healthy banking sector.
Mulberry commented, “The banking sector shows unexpected strength, providing reassurance that the financial system remains robust. However, we are closely monitoring the situation, as prolonged high interest rates may lead to increased stress.”