As interest rates reach their highest levels in over 20 years and inflation continues to pressure consumers, major banks are preparing for increased risks stemming from their lending practices.
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 banks set aside to cover potential losses from credit risks, including bad debts and delinquent loans, particularly in commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance reached $21.8 billion, more than tripling its credit reserve from the prior quarter, and Wells Fargo accounted for $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier environment, where both secured and unsecured loans could result in significant losses. Recent data from the New York Federal Reserve revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards, along with rising delinquency rates, is also growing as individuals deplete their pandemic savings and increasingly depend on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter in which total cardholder balances exceeded this threshold. The commercial real estate sector remains particularly vulnerable.
According to Brian Mulberry, a portfolio manager at Zacks Investment Management, the aftermath of the COVID era influences the banking sector and consumer health largely due to the stimulus measures that were enacted.
However, challenges for banks are expected to emerge in the coming months. As Mark Narron, a senior director at Fitch Ratings, pointed out, the provisions that banks report do not solely reflect credit quality over the last quarter but rather their forecasts for future conditions.
“There’s a shift from a traditional model where poor loan performance would drive up provisions to one that is influenced by macroeconomic projections,” Narron stated.
In the short term, banks anticipate a slowdown in economic growth, a rise in unemployment rates, and two interest rate cuts later this year in September and December, which could lead to increased delinquencies and defaults.
Citi’s CFO Mark Mason emphasized that indications of financial strain are particularly evident among lower-income consumers who have seen their savings diminish since the pandemic.
“While the overall U.S. consumer appears resilient, we’re witnessing disparities in performance based on income levels and credit scores,” Mason noted during a recent call with analysts. He remarked that only the highest income quartile has managed to save more compared to 2019, with only customers boasting high credit scores driving growth in spending and maintaining payment rates.
Simultaneously, the Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, with plans to consider cutting rates once inflation stabilizes towards its 2% target.
As banks brace for potential increases in default rates later this year, current data does not yet indicate a consumer crisis. Mulberry is particularly focused on the contrast between homeowners and renters during the pandemic.
Although interest rates have risen significantly, homeowners with long-term fixed-rate mortgages are largely insulated from immediate financial stress. In contrast, renters, facing a 30% increase in rents from 2019 to 2023 and a 25% rise in grocery costs, are experiencing considerable strain on their budgets.
For the time being, the latest earnings reports suggest stability in asset quality and robust revenues, profits, and net interest income, reflecting a healthy banking sector.
“Despite the predictability of the current financial landscape, the banking sector retains notable strength,” Mulberry concluded. “However, we remain vigilant, as prolonged high-interest rates could lead to increased stress.”