As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for potential risks linked to their lending activities.
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, including problems related to delinquent debts and loans, particularly in commercial real estate.
JPMorgan allocated $3.05 billion to provisions for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses surged to $21.8 billion, more than tripling its reserves from the prior quarter. Wells Fargo increased its provisions to $1.24 billion.
These additional reserves indicate that banks are preparing for what they see as a riskier financial environment, where both secured and unsecured loans could lead to greater losses. According to a recent analysis by the New York Federal Reserve, Americans are facing a collective debt of $17.7 trillion from consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also climbing as many individuals deplete their pandemic-era savings and increasingly rely on credit. Total credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where the total surpassed a trillion dollars. Additionally, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector is still navigating the aftermath of the COVID-19 pandemic and the subsequent consumer stimulus measures.
Experts suggest that any significant challenges for banks are likely to emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, pointed out that quarterly provisions do not necessarily represent credit quality from the past three months but reflect expectations for future trends.
Currently, banks anticipate slowing economic growth, rising unemployment, and potential interest rate cuts in September and December, which could result in increased delinquencies and defaults as 2023 closes.
Citi’s CFO Mark Mason highlighted that the stress appears to be primarily affecting lower-income consumers, who are running low on savings since the pandemic. While the overall U.S. consumer remains resilient, disparities exist in performance among different income levels and credit scores.
According to Mason, only the highest income quartile has maintained more savings than before 2019, with consumers holding credit scores above 740 driving spending growth and sustaining high payment rates. In contrast, those with lower credit scores are facing significant challenges, borrowing more while struggling with high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation towards a 2% target before implementing anticipated rate cuts.
Despite the preparations for an increase in defaults later this year, Mulberry assessed that current default rates do not yet indicate a consumer crisis. He noted the ongoing effects of interest rates on different groups, emphasizing that homeowners who secured low fixed rates during the pandemic are still managing well, while renters face substantial financial pressure.
The period from 2019 to 2023 has seen rents increase by over 30% and grocery prices grow by 25%, creating challenges for renters who did not benefit from lower rates.
Overall, the most recent earnings reports suggest stability within the banking sector, with no major new concerns about asset quality. Strong revenue and profits, along with robust net interest income, indicate that the financial system remains solid. However, Mulberry cautioned that ongoing high-interest rates could increase stress over time.