With interest rates at their highest levels in over 20 years and inflation affecting consumers, major banks braced for potential 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 represent funds set aside to cover potential losses from credit risks, such as delinquent or bad debts and various types of loans, including commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, more than tripling its reserve build from the prior quarter. Wells Fargo reported provisions of $1.24 billion.
These increases indicate that banks are preparing for a more challenging financial environment, where both secured and unsecured loans could result in greater losses. According to a recent analysis by the New York Fed, American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as consumers deplete their pandemic-era savings and increasingly rely on credit. In the first quarter of this year, credit card balances hit $1.02 trillion, the second consecutive quarter surpassing the trillion-dollar mark, as reported by TransUnion. Additionally, the CRE sector remains in a vulnerable state.
Experts note that the impact of the COVID-19 pandemic and the accompanying stimulus measures have shaped consumer behavior and bank performance. However, challenges for banks may emerge in the coming months.
The provisions observed in any quarter do not solely reflect the recent credit quality but also represent banks’ expectations for the future, as explained by Mark Narron, a senior director at Fitch Ratings.
Short-term projections for banks indicate slower economic growth, an increase in unemployment, and anticipated interest rate cuts in September and December, which could lead to more delinquency and defaults as the year concludes.
Mark Mason, Citi’s chief financial officer, pointed out that financial challenges seem to be concentrated among lower-income consumers, who have seen their savings diminish since the pandemic.
While overall U.S. consumer resilience remains strong, there are noticeable differences in performance based on income and credit scores. The highest income quartile has more savings than they did at the start of 2019, according to Mason, while lower-FICO customers are experiencing steeper declines in payment rates and increased borrowing due to inflation and rising interest rates.
The Federal Reserve is maintaining interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation towards its 2% target before implementing expected rate cuts.
Despite banks gearing up for an increase in defaults later in the year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He emphasized the distinction between homeowners, who secured low fixed-rate mortgages during the pandemic, and renters, who are now dealing with a surge in rental prices.
With national rent prices climbing over 30% from 2019 to 2023 and grocery costs rising 25%, renters lacking low-rate opportunities feel the most financial strain, Mulberry noted.
For the time being, the latest earnings results suggested no new issues in asset quality. Strong revenues, profits, and net interest income indicate that the banking sector remains generally sound and healthy. Mulberry remarked that the banking sector is exhibiting unexpected strength, though the sustained high-interest rates could lead to increased stress in the future.