With interest rates reaching their highest levels in over 20 years and inflation continuing to pressure consumers, major banks are bracing for increased risks associated with their lending practices.
JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all raised their provisions for credit losses in the second quarter compared to the previous quarter. These provisions are funds set aside by banks to cover potential losses from credit risks, including defaults and bad debts related to lending, such as commercial real estate loans.
In the second quarter, JPMorgan allocated $3.05 billion for credit losses, while Bank of America set aside $1.5 billion. Citigroup’s total allowance for credit losses reached $21.8 billion at the end of the quarter, more than tripling its reserves from the previous quarter. Wells Fargo’s provisions amounted to $1.24 billion.
These provisions indicate that banks are preparing for a more challenging financial environment, where both secured and unsecured loans could lead to greater losses. A recent study by the New York Fed revealed that Americans collectively owe around $17.7 trillion across consumer loans, student loans, and mortgages.
The rise in credit card issuance and delinquency rates coincides with consumers depleting their savings from the pandemic and increasingly relying on credit. In the first quarter of this year, credit card balances surpassed $1 trillion, marking the second consecutive quarter this has occurred, according to TransUnion. Additionally, commercial real estate remains unstable.
“We’re still emerging from the COVID period, and the health of banking and consumers has largely depended on the stimulus provided during that time,” explained Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Challenges for banks are anticipated in the upcoming months, as the provisions noted in current quarters don’t necessarily reflect the recent credit quality but are more indicative of future expectations, according to Mark Narron, a senior director at Fitch Ratings.
The banks predict a slowdown in economic growth, a rise in unemployment rates, and two potential interest rate cuts later this year. This could lead to increased delinquencies and defaults as the year closes.
Citi’s CFO Mark Mason highlighted that concerns are especially pronounced among lower-income consumers, who have seen their savings diminish since the pandemic. “While the overall U.S. consumer remains resilient, there is a marked divergence in performance and behavior by income level,” Mason remarked during an analyst call. He noted that only the highest income quartile has managed to save more since early 2019, with those having scores above 740 driving spending growth. Conversely, lower FICO score customers are experiencing significant declines in payment rates and are turning to borrowed funds as they deal with the impacts of high inflation and interest rates.
The Federal Reserve continues to maintain interest rates between 5.25% and 5.5%, waiting for inflation measures to stabilize towards its 2% target before any anticipated rate cuts.
Despite the preparation for broader defaults later in the year, there is currently no significant increase in defaults that signals a consumer crisis, according to Mulberry. He is particularly monitoring the distinction between homeowners and renters from the pandemic period. Homeowners, having secured low fixed-rate loans, are reportedly less impacted by rising rates, while renters face financial strain due to increased rental costs, which have risen over 30% nationwide since 2019, alongside a 25% increase in grocery prices.
Overall, the latest earnings reports reveal no significant asset quality deterioration. Positive earnings, profits, and resilient net interest income suggest a strong banking sector. “There’s a robustness in the banking system that, while not entirely unexpected, is certainly reassuring and reflects the system’s solid structure,” Mulberry stated. However, he cautioned that prolonged high interest rates could lead to increased stress in the financial system.