As interest rates reach their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing 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 represent the funds that banks allocate to cover potential losses from credit risks, including delinquent debts and loans, such as those related to commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance totaled $21.8 billion at the end of the quarter, significantly more than its previous credit reserve, and Wells Fargo reported provisions of $1.24 billion.
These increased provisions indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans could lead to greater losses. An analysis by the New York Federal Reserve found that Americans collectively owe $17.7 trillion in various types of loans, including consumer and student loans as well as mortgages.
Moreover, credit card issuance and delinquency rates are on the rise as consumers deplete their pandemic-era savings, leading many to rely more on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector remains under significant pressure.
As Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted, “We’re still coming out of this COVID era,” emphasizing the impact of stimulus efforts on banking and consumer health.
However, the problems banks may face will likely emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported each quarter do not necessarily reflect credit quality from the prior three months but rather banks’ expectations for the future.
“Our move from a system where bad loans drive up provisions to one where macroeconomic forecasts are the main influence is noteworthy,” Narron added.
In the short term, banks are forecasting slower economic growth, a higher unemployment rate, and potential interest rate cuts later in the year. This could translate to increased delinquencies and defaults as the year concludes.
Citigroup’s CFO Mark Mason highlighted that warning signs are predominantly affecting lower-income consumers, who have seen their savings diminish since the pandemic. He pointed out that while the overall U.S. consumer remains resilient, significant disparities exist among different income levels and credit scores.
Mason further indicated, “Only the highest income quartile has more savings than they did at the start of 2019, with customers maintaining high payment rates being those with FICO scores over 740. Lower FICO customers are experiencing drops in payment rates and borrowing more due to the impacts of inflation and high interest rates.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it monitors inflation metrics towards a target of 2% before implementing anticipated rate cuts.
Despite banks expecting wider defaults in the latter half of the year, Mulberry remarked that defaults have not surged to levels indicating a consumer crisis. He noted a key difference between homeowners during the pandemic, who secured low fixed-rate mortgages, and renters who did not have this opportunity.
“Homeowners, while facing increased rates, are still not feeling the financial strain significantly,” he explained, contrasting their situation with that of renters whose costs have risen more than 30% nationally since 2019.
At present, analysts perceive the most significant message from the recent earnings reports is that there have been no major new concerns regarding asset quality. Strong revenues, profits, and net interest income suggest that the banking sector remains healthy overall.
Mulberry stated, “There’s some strength in the banking sector that is reassuring. The structures of the financial system are still very strong and sound. However, we are closely monitoring the situation, as prolonged high-interest rates could lead to more stress.”