As interest rates reach levels not seen in over two decades and inflation continues to affect consumers, major banks are bracing for increased risks associated with their lending activities.
In the second quarter, leading financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds set aside by banks to cover potential losses from credit risks, including delinquent loans and bad debt, particularly in commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses during the second quarter, while Bank of America designated $1.5 billion. Citigroup’s credit loss allowance reached $21.8 billion at the end of the quarter, a significant increase from the previous period, and Wells Fargo allocated $1.24 billion in provisions.
These increased reserves indicate that banks are preparing for a more challenging financial landscape, where both secured and unsecured loans could potentially result in greater losses. A report by the New York Federal Reserve revealed that American households currently owe a staggering $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card debt is also climbing, with delinquency rates on the rise as consumers begin to exhaust their savings from the pandemic era. According to TransUnion, credit card balances soared to $1.02 trillion in the first quarter, marking the second consecutive quarter where totals exceeded the trillion-dollar threshold. The CRE sector remain vulnerable amid these conditions.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking industry is still recovering from the effects of the COVID-19 pandemic, driven largely by government stimulus.
Looking ahead, banks are expected to face challenges in the coming months. Mark Narron, a senior director at Fitch Ratings, emphasized that the credit provisions reported by banks often reflect their expectations for future credit quality rather than just past performance.
In light of projections predicting slower economic growth, higher unemployment, and potential interest rate cuts later this year, there could be an increase in delinquencies and defaults.
Citi’s chief financial officer, Mark Mason, pointed out that the financial strain appears to be more pronounced among lower-income consumers, whose savings have diminished since the pandemic. He highlighted that only those in the highest income quartile have seen a boost in savings since 2019. Customers with a FICO score above 740 are driving spending growth and maintaining high payment rates, while those with lower scores face dwindling payment rates and increased borrowing due to rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high between 5.25% and 5.5%, awaiting stabilization in inflation to reach its 2% target before any anticipated rate reductions.
Despite banks preparing for a potential rise in defaults later this year, experts indicate that defaults have not yet increased to a level that signals a consumer crisis. Mulberry is particularly observing the divide between homeowners and renters, noting that homeowners with fixed low rates are less affected by rising costs compared to renters, who are facing significant financial pressure from escalating rent and grocery costs.
In summary, the latest earnings reports did not reveal any new issues surrounding asset quality, as banks exhibited strong revenues, profits, and a resilient net interest income, suggesting a still-healthy financial sector. Mulberry remarked that while current conditions are stable, prolonged high interest rates could lead to increased stress within the banking system.