Amidst interest rates reaching over two-decade highs and persistent inflation impacting consumers, major banks are bracing for potential risks associated with their lending operations.
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 reserves set aside to mitigate potential losses from credit risks, including overdue debts and lending such as commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses rose to $21.8 billion by the quarter’s end, representing a threefold increase from the prior period, and Wells Fargo reported provisions of $1.24 billion.
The accumulation of these reserves indicates that banks are preparing for a more challenging environment, where both secured and unsecured loans could lead to increased losses for some of the largest financial institutions in the country. According to the New York Fed, Americans currently have a total household debt of $17.7 trillion, comprising consumer loans, student loans, and mortgages.
There is also a noticeable uptick in credit card issuance and delinquency rates as individuals exhaust their pandemic 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 that cumulative cardholder balances surpassed the trillion-dollar benchmark, as per TransUnion. Moreover, the CRE sector remains under significant stress.
“We’re still emerging from the COVID era, particularly in the banking sector and consumer health, largely due to the stimulus provided to consumers,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, the challenges facing banks are anticipated to manifest in the coming months.
“The provisions that you observe in any given quarter do not necessarily reflect credit quality for the preceding three months; they are indicative of banks’ expectations for the future,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
Narron added, “It’s interesting because we have shifted from a historical approach where rising loan defaults would increase provisions, to a model where macroeconomic forecasts primarily influence provisioning.”
In the short term, banks expect to see slowing economic growth, higher unemployment rates, and two anticipated interest rate cuts later this year, which could lead to more delinquencies and defaults by year-end.
Citigroup’s chief financial officer, Mark Mason, highlighted that these warning signs seem to be particularly acute among lower-income consumers, who have seen their savings diminish since the pandemic.
“While we still observe an overall resilient U.S. consumer, there’s a noticeable divergence in performance and behavior across economic brackets,” Mason stated during a recent analyst call.
He noted that among their consumer clients, only those in the highest income quartile have more savings compared to early 2019, with customers holding FICO scores above 740 driving spending and maintaining high payment rates. Meanwhile, customers with lower FICO scores are experiencing significant drops in payment rates and are borrowing more, facing the brunt of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, monitoring inflation metrics before proceeding with anticipated rate cuts.
Despite banks preparing for more defaults later in the year, Mulberry suggests that current default rates do not yet signal a consumer crisis. He points out a key distinction between homeowners and renters during the pandemic.
“Yes, rates have risen substantially, but homeowners secured very low fixed rates on their debt, so they aren’t feeling the financial strain as much,” Mulberry explained. “In contrast, renters who missed that opportunity are facing challenges.”
Over the past few years, rents have surged over 30% and grocery costs have increased by 25%, placing significant pressure on renters who have not benefited from low-rate mortgages and whose income growth has not kept pace with rising living costs.
Ultimately, the latest earnings from banks indicate that there aren’t new issues regarding asset quality. Strong revenues, profits, and resilient net interest income reflect a healthy banking sector.
“There is strength in the banking sector that may not have been entirely unexpected, but it’s reassuring to know that the foundations of the financial system remain robust,” Mulberry commented. “However, we are closely monitoring the situation, as prolonged high interest rates may induce more stress.”