As interest rates reach their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for heightened risks in their lending operations.
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 the funds that financial institutions reserve to cover potential losses from credit risks such as delinquent loans and risky lending, including 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 allowance for credit losses reached $21.8 billion at the end of the quarter, representing a substantial increase from earlier. Wells Fargo provisioned $1.24 billion in this area.
These increased reserves indicate that banks are preparing for a more challenging financial environment, where both secured and unsecured loans may lead to larger losses. A recent analysis by the New York Federal Reserve highlighted that Americans currently owe a total of $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. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where the total exceeded one trillion dollars, according to TransUnion. Additionally, the commercial real estate sector remains in a vulnerable state.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted the lingering effects of the COVID-19 pandemic on banking and consumer health, emphasizing the role of stimulus measures on consumer financial conditions.
However, any serious challenges for banks may materialize in the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, explained that the provisions for credit losses do not necessarily reflect the current state of credit quality but rather banks’ expectations for future conditions.
He added that banks are currently anticipating slower economic growth, a higher unemployment rate, and potential interest rate cuts in September and December. These factors could contribute to an increase in delinquencies and defaults by the end of the year.
Citigroup’s CFO Mark Mason pointed out that the financial stress appears more concentrated among lower-income consumers, who have seen their savings decrease since the pandemic.
While the U.S. consumer market remains overall resilient, there is a noticeable divergence in financial performance and behavior based on income and credit scores. Only high-income households have managed to maintain higher savings compared to levels at the beginning of 2019, with those in the lower credit score brackets experiencing significant drops in payment rates due to the impacts of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it seeks to stabilize inflation towards its 2% target before implementing any expected rate cuts.
Although banks are preparing for potential defaults in the latter part of the year, current trends do not indicate a consumer crisis yet, according to Mulberry. He highlighted a contrast between homeowners, who have locked in low fixed mortgage rates, and renters, who are facing rising rents and costs.
Overall, strong revenues and profits among banks signal a still-healthy banking sector, with no significant new issues related to asset quality noted this quarter. Mulberry emphasized that while the banking sector remains robust, the enduring high interest rates are likely to create ongoing stress.