With interest rates at their highest levels in over two decades and inflation posing continued challenges for consumers, major banks are gearing up for increased risks in their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo each heightened their provisions for credit losses compared to the previous quarter. These provisions, which serve as a financial cushion against potential bad debts and defaults on loans, include areas like commercial real estate (CRE) financing.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses amounted to $21.8 billion at the end of the quarter, significantly more than the previous quarter’s figures. Wells Fargo earmarked $1.24 billion for this purpose.
These increased provisions reflect the banks’ anticipation of a riskier lending landscape, where both secured and unsecured loans may lead to heightened losses for these prominent financial institutions. A recent report from the New York Fed highlighted that American households collectively owe $17.7 trillion across various types of loans, including consumer loans, mortgages, and student debt.
Credit card issuance is also experiencing a surge, with delinquency rates climbing as consumers deplete their pandemic-era savings and increasingly turn to credit. Credit card balances reached $1.02 trillion in the first quarter—marking the second consecutive quarter that totals surpassed the $1 trillion threshold, according to TransUnion. Additionally, the commercial real estate sector remains uncertain.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted the lingering effects of the COVID-19 era, especially regarding consumer financial health, which was bolstered by substantial stimulus measures during the pandemic.
However, potential issues for the banks are expected to surface in the coming months. According to Mark Narron, a senior director at Fitch Ratings, current provisions do not merely reflect recent credit quality but are based on banks’ forecasts for future economic conditions.
The banks project a deceleration in economic growth, a rise in unemployment, and anticipate interest rate cuts in September and December. This environment could lead to increased delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, highlighted that the warning signals seem to affect lower-income consumers disproportionally, who have seen their savings erode in the aftermath of the pandemic.
While the overall U.S. consumer remains resilient, disparities exist in performance and behavior depending on income and credit scores. According to Mason, only the highest income quartile has maintained greater savings compared to early 2019, while lower FICO score customers face declining payment rates and heightened reliance on credit due to rising inflation and interest rates.
As the Federal Reserve maintains interest rates at a 23-year high of 5.25-5.5%, it awaits signs of inflation stabilizing towards its 2% target before enacting anticipated cuts.
Despite banks bracing for more defaults in the latter half of the year, current default rates do not indicate an imminent consumer crisis, according to Mulberry. He is particularly paying attention to the divide between homeowners and renters from the pandemic period.
While interest rates have risen significantly, Mulberry pointed out that homeowners have benefited from locking in low fixed rates, thus avoiding immediate financial pressure. In contrast, renters are feeling the brunt of increased housing costs and inflation, with nationwide rents soaring over 30% from 2019 to 2023 alongside a 25% rise in grocery prices.
For the moment, the main takeaway from the latest earnings reports is that there have been no alarming developments concerning asset quality. Strong revenues and profits, along with robust net interest income, indicate a still-healthy banking sector.
Mulberry expressed relief at the current strength in the financial system, emphasizing that continued high interest rates will inevitably exert more pressure on the sector.