Amid rising interest rates, which are at their highest in over two decades, and persistent inflation affecting consumers, major banks are bracing for increased risks associated with their lending policies.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all boosted their reserves for credit losses compared to the previous quarter. These reserves are intended to cover potential losses from credit risk, including delinquent debts and issues related to commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s total credit loss allowance reached $21.8 billion, more than tripling its reserves from the previous quarter. Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves signal that banks are anticipating a more challenging economic climate, where both secured and unsecured loans may lead to more significant losses. A recent analysis by the New York Federal Reserve revealed that U.S. households collectively owe $17.7 trillion across consumer loans, student debt, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as pandemic savings diminish and consumers increasingly rely on credit. In the first quarter, credit card balances hit $1.02 trillion, marking the second consecutive quarter that total balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also remains under pressure.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted the ongoing effects of the COVID pandemic on consumer finances, emphasizing the role of government stimulus during that time.
Looking ahead, experts warn that banks might face more challenges. Mark Narron, a senior director at Fitch Ratings, pointed out that current provisions may not accurately reflect recent credit quality but rather indicate expectations about future credit conditions.
In the short term, banks anticipate slower economic growth, increased unemployment, and potential interest rate cuts later this year in September and December. This could lead to more delinquencies and defaults as the year progresses.
Mark Mason, Citigroup’s chief financial officer, highlighted concerns concentrated among lower-income consumers, who have seen their savings diminish since the pandemic.
While the overall U.S. consumer remains robust, Mason noted a divergence in financial health across income levels and credit scores. Only the highest-income quartile has increased their savings since early 2019, with those in the over-740 FICO score range driving spending growth and maintaining high payment rates. Conversely, lower-FICO customers are experiencing significant drops in payment rates and are borrowing more due to the impact of high inflation and interest rates.
The Federal Reserve continues to hold interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation toward the central bank’s target of 2%.
Despite banks preparing for a rise in defaults later this year, Mulberry noted that current default rates do not yet indicate a consumer crisis. He is particularly watching the divide between homeowners and renters, as homeowners who locked in low fixed rates are largely insulated from the pain of rising rates, unlike renters who face significantly increased costs.
From the latest earnings reports, it has been observed that asset quality remains relatively stable. Strong revenues, profits, and robust net interest income all suggest a healthy banking sector. Mulberry commented on the resilience of the financial system, while also cautioning that prolonged high-interest rates could create more stress for consumers.