With interest rates reaching their highest level in over 20 years and inflation continuing to affect consumers, major banks are anticipating increased risks associated with their lending activities.
In the second quarter, major financial institutions like JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions represent funds set aside by banks to cover potential losses from credit risk, including delinquent debts and bad loans, particularly in the commercial real estate sector.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s credit loss allowance reached $21.8 billion, more than tripling its reserve build from the previous quarter, and Wells Fargo reported provisions of $1.24 billion.
These heightened reserves indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans could result in significant losses. A recent report by the New York Federal Reserve highlighted that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also increasing as consumers deplete their savings accrued during the pandemic and increasingly rely on credit. In the first quarter of this year, credit card balances surpassed $1.02 trillion for the second consecutive quarter, as noted by TransUnion. Additionally, the commercial real estate market remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked, “We’re still coming out of this COVID era, specifically regarding banking and consumer health, largely due to the stimulus that was provided to consumers.”
Looking ahead, banks are expecting challenges in the months to come. Mark Narron, a senior director at Fitch Ratings, pointed out that the provisions reported by banks reflect their expectations for future credit quality rather than past performance.
He explained that the banking sector has shifted from a model where increasing loan defaults would prompt higher provisions to one where macroeconomic forecasts drive provisioning decisions.
Current projections indicate a slowdown in economic growth, a rise in unemployment, and potential interest rate cuts later this year, which could lead to increased delinquencies and defaults.
Citi’s CFO Mark Mason has identified concerns primarily among lower-income consumers, who have seen a decline in their savings since the pandemic. He noted, “While overall U.S. consumers remain resilient, there is a noticeable divergence in performance and behavior across income levels and credit scores.”
He added that only the highest income quartile has maintained more savings than in early 2019. This trend suggests that customers with higher credit scores are contributing more to spending growth and maintaining higher payment rates, while those in lower credit score brackets are borrowing more and experiencing a drop in payment rates due to the impact of rising inflation and interest rates.
The Federal Reserve has kept interest rates high at 5.25% to 5.5%, awaiting stabilization of inflation measures toward the central bank’s 2% target before implementing anticipated rate cuts.
Even though banks are bracing for a potential increase in defaults later in the year, Mulberry believes that current default rates do not indicate an impending consumer crisis. He is particularly observing the difference between homeowners who secured low fixed-rate mortgages during the pandemic and renters who are now facing higher living costs.
“Homeowners, despite rising rates, tend to have benefitted from locking in low rates, so they might not feel the pressure as much,” Mulberry stated. “In contrast, renters, who didn’t have the same opportunity, have seen rental prices surge over 30% nationwide since 2019, alongside a 25% rise in grocery costs, which is significantly impacting their budgets.”
Currently, the essential takeaway from the latest round of bank earnings is that there have been no substantial new concerns regarding asset quality. Strong revenues, profits, and robust net interest income reflect continued health in the banking sector.
Narron summarized, “The banking sector is demonstrating resilience, which is somewhat reassuring. However, we must remain vigilant as prolonged high-interest rates could lead to increased stress in the future.”