As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks in their lending practices.
In the second quarter, leading banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo heightened their provisions for credit losses compared to the previous quarter. These provisions are funds that banks allocate to mitigate potential losses from credit risks, including delinquent or bad debts related to lending, particularly in commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s allowance for credit losses rose to $21.8 billion by the end of the quarter, significantly up from the previous period; while Wells Fargo put aside $1.24 billion.
These increased reserves indicate that banks are preparing for a more hazardous lending environment, where both secured and unsecured loans may lead to larger losses for prominent financial institutions. A recent study by the New York Federal Reserve revealed that American households are in debt for a total of $17.7 trillion across consumer loans, student loans, and mortgages.
Additionally, the issuance of credit cards and delinquency rates are climbing, as many individuals deplete their pandemic savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances surpassed the trillion dollar milestone, according to TransUnion. The commercial real estate sector continues to face uncertainty as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked on the lingering effects of the COVID-19 pandemic, particularly regarding banking and consumer health, emphasizing the role of government stimulus during this period.
Experts caution that banks may face challenges in the coming months. Mark Narron, a senior director at Fitch Ratings, pointed out that the provisions set by banks each quarter do not necessarily reflect the immediate credit quality but rather predictions of future developments.
Banks are anticipating slower economic growth, a rise in unemployment, and two expected interest rate cuts later this year, potentially leading to higher rates of delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, highlighted that warning signs are particularly evident among lower-income consumers, who have suffered declines in their savings since the pandemic began. He noted a disparity in consumer behavior based on income and credit scores, with only the highest-income quartile having increased their savings since early 2019.
Mason explained that higher-income and higher credit score consumers are driving spending growth, whereas those with lower credit scores are experiencing declining payment rates and increasing borrowing as they navigate the challenges of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a peak of 5.25-5.5% for 23 years, awaiting stabilization in inflation towards its 2% target before implementing anticipated rate cuts.
Despite banks preparing for potential defaults, Mulberry observed that current default rates do not indicate an immediate consumer crisis. He is closely monitoring the contrast between homeowners and renters from the pandemic era. Homeowners, having secured low fixed rates on their debt, are less affected by rising rates, while renters face increased pressures from escalating rents and grocery costs.
While recent earnings reports did not reveal new concerns regarding asset quality, they did showcase solid revenues, profits, and resilient net interest income, reflecting a generally healthy banking sector. Mulberry noted a reassuring strength within the banking system but cautioned that prolonged high interest rates will inevitably contribute to increased stress.