As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks associated with 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 are reserves set aside by financial institutions to cover potential losses from credit risks, which can include delinquent debts and various lending types, such as commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s total allowance for credit losses reached $21.8 billion, marking more than a threefold increase from the previous quarter. Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves indicate that banks are preparing for a potentially riskier environment, where both secured and unsecured loans could lead to more significant losses. The New York Fed’s recent analysis revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise as consumers deplete their pandemic-era savings and increasingly rely on credit. As of the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter where cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. Meanwhile, commercial real estate continues to face uncertainties.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted the lingering effects of the COVID-19 pandemic on the banking sector and consumer health, largely tied to the stimulus given to consumers during that time.
However, challenges for banks are expected in the coming months. Mark Narron, a senior director at Fitch Ratings, emphasized that the provisions recorded in any quarter often do not represent the immediate credit quality but instead reflect banks’ forecasts of future economic conditions.
Currently, banks anticipate slower economic growth, an increase in unemployment, and the potential for two interest rate cuts later this year, which could lead to heightened delinquencies and defaults by year-end.
Citi’s chief financial officer, Mark Mason, highlighted that concerning indicators appear to be centered on lower-income consumers, who have experienced a decline in savings since the pandemic. He pointed out a noticeable disparity between consumer groups, stating, “Only the highest income quartile has more savings than they did at the beginning of 2019.”
Mason also noted that customers with FICO scores over 740 are driving spending growth and maintaining high payment rates, while those in lower FICO bands are more affected by rising inflation and interest rates, leading to declining payment rates and increased borrowing.
The Federal Reserve has maintained interest rates at a 23-year high between 5.25% and 5.5%, awaiting signs of stabilization in inflation towards the central bank’s 2% target before considering rate cuts.
Despite banks preparing for potential defaults in the latter half of the year, the current rate of defaults does not yet indicate a consumer crisis, according to Mulberry. He emphasized the differing situations of homeowners and renters. Homeowners, who locked in low fixed rates, are less impacted by rising rates compared to renters, who have faced soaring rental prices due to a significant increase in rents and grocery costs.
Overall, the recent earnings reports reveal no new issues in asset quality, with strong revenues, profits, and net interest income suggesting continued health in the banking sector. Mulberry expressed cautious optimism, noting that while the financial system remains robust, sustained high-interest rates could lead to increasing stress in the future.