As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks associated with 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 funds that banks set aside to cover potential losses from credit risk, including defaults on loans and issues in commercial real estate lending.
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s allowance reached $21.8 billion, which more than tripled its reserves from the prior quarter; and Wells Fargo had provisions totaling $1.24 billion.
These increased reserves signal a readiness from banks to navigate a more challenging landscape, where both secured and unsecured loans may lead to larger losses. A recent analysis from the New York Fed indicated that American households carry a total of $17.7 trillion in debt, covering consumer loans, student loans, and mortgages.
Credit card usage and delinquency rates are rising as people exhaust the savings they accrued during the pandemic, increasingly relying on credit. In the first quarter of this year, credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. Additionally, the commercial real estate sector is facing significant challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked that the ongoing transition from the pandemic era, particularly in banking and consumer health, was largely influenced by the stimulus measures provided to consumers.
However, banks anticipate that any potential issues will likely arise in the coming months.
Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported in any given quarter do not necessarily reflect recent credit quality but rather what banks foresee in the future.
He noted, “We are witnessing a shift from a historical system where an increase in bad loans would prompt higher provisions to one where macroeconomic forecasts dictate provisioning.”
Banks are predicting slower economic growth, a higher unemployment rate, and possible interest rate cuts later this year in September and December, which could lead to increased delinquencies and defaults by year-end.
Citigroup’s CFO Mark Mason pointed out that the concerns about credit risk primarily affect lower-income consumers whose savings have dwindled since the pandemic. He stated that while the overall U.S. consumer remains resilient, there is a noticeable disparity in performance across different income and credit score brackets.
According to Mason, only the top income quartile has maintained higher savings than before 2019, with those having credit scores above 740 driving spending growth and keeping up with payments. In contrast, lower credit score customers are experiencing sharper declines in payment rates and are borrowing more due to the strain of high inflation and interest rates.
The Federal Reserve has held interest rates at a 23-year high of 5.25% to 5.5%, awaiting more stable inflation data before executing the anticipated rate cuts.
Despite banks preparing for potential defaults in the latter half of the year, current default rates are not yet indicative of a consumer crisis, according to Mulberry. He suggested a division between homeowners and renters during the pandemic, noting that homeowners have largely benefited from low fixed-rate mortgages and are less affected by rising rates.
In contrast, renters, facing a more than 30% rise in rental costs and a 25% increase in grocery prices since 2019, are under significant financial pressure as their expenses outpace wage growth.
Overall, the latest earnings reports revealed no significant changes in asset quality. Positive indicators such as strong revenues, profits, and resilient net interest income suggest that the banking sector remains robust.
Mulberry commented, “There is strength in the banking sector that may not have been entirely expected, and it is reassuring to see that the financial system’s structures are solid at this time. However, we are closely monitoring the situation, as prolonged high interest rates could introduce more stress.”