As interest rates hit the highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for potential risks in 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 represent the funds that banks set aside to cover anticipated losses from credit risks, including overdue debts and various types of loans, such as commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses during the second quarter, while Bank of America earmarked $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, marking more than a threefold increase from the previous quarter. Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a challenging economic environment, anticipating that both secured and unsecured loans may lead to greater losses. A recent analysis by the New York Fed revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards and the rates of delinquency are also on the upswing as consumers exhaust their pandemic savings and rely more heavily on credit. In the first quarter of this year, credit card balances hit $1.02 trillion, marking the second consecutive quarter in which total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. Additionally, CRE continues to face uncertainties.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the ongoing transition from the COVID-era stimulus effects on banking and consumer health.
Challenges for banks are expected to emerge in the upcoming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions recorded in any given quarter do not necessarily reflect past credit quality but rather banks’ expectations for the future.
He noted a shift in how provisioning is influenced by macroeconomic forecasts rather than purely by the performance of loans. In the near future, banks expect a slowdown in economic growth, a rise in unemployment, and potential interest rate cuts later in the year, which might lead to increased defaults and delinquencies.
Citi’s chief financial officer Mark Mason pointed out that the warning signs seem to predominantly affect lower-income consumers, who have seen their savings diminish since the pandemic.
Mason highlighted the disparities in financial stability, stating, “While we continue to see an overall resilient U.S. consumer, we also continue to see a divergence in performance and behavior across FICO and income bands.” He mentioned that only the highest income group has more savings than they did in early 2019, with those holding over a 740 FICO score driving spending growth and maintaining high payment rates. Conversely, lower FICO score customers are facing declining payment rates and increased borrowing due to the pressure of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% while waiting for inflation to stabilize towards its target of 2% before potentially implementing anticipated rate cuts.
Despite preparations for more widespread defaults, current default rates do not indicate an impending consumer crisis, according to Mulberry. He is particularly attentive to how the experiences diverge between homeowners and renters during the pandemic.
While interest rates have risen significantly, Mulberry noted that homeowners locked in low fixed rates and are not experiencing as much financial strain as renters. He explained, “If you were renting during that period of time, you didn’t get that opportunity.” With rents increasing by over 30% nationwide from 2019 to 2023 and grocery costs rising by 25%, renters are facing considerable financial stress.
Overall, analysts conclude that the most recent earnings reports did not reveal any new issues concerning asset quality. They noted that strong revenues, profits, and robust net interest income are encouraging signs of a healthy banking sector. Mulberry remarked that while the banking system appears sound, extended periods of high interest rates could lead to increased stress in the financial landscape.