As interest rates remain at their highest levels in over two decades and inflation continues to challenge consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their credit loss provisions compared to the previous quarter. These reserves are intended to cover potential losses linked to credit risks, including overdue debts and various loans, such as those in commercial real estate.
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 by the end of the quarter, marking a tripling of its credit reserve from the prior quarter. Meanwhile, Wells Fargo’s provisions totaled $1.24 billion.
These increased reserves indicate that banks are preparing for a high-risk environment, where losses from both secured and unsecured loans may rise. A recent New York Fed analysis revealed that Americans currently owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card use and delinquency rates are also climbing as pandemic-era savings diminish and consumers increasingly depend on credit. Total credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where the total surpassed the trillion-dollar mark, according to TransUnion. Additionally, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted the lingering effects of the COVID-19 pandemic on banking and consumer health, particularly regarding stimulus measures provided to consumers.
Experts suggest that any significant challenges for banks may arise in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions may not accurately reflect recent credit quality but instead indicate banks’ expectations for the future.
Banks are forecasting slower economic growth and a potential rise in the unemployment rate, along with anticipated interest rate cuts in September and December, which could result in heightened delinquencies and defaults by year-end.
Citi’s chief financial officer Mark Mason pointed out that emerging issues seem concentrated among lower-income consumers, who have faced declining savings since the pandemic started. He remarked that while the overall U.S. consumer remains resilient, there are stark differences in behavior depending on income and credit score levels.
Mason observed that only the top income quartile has increased savings since early 2019, with high-credit score customers driving spending growth and maintaining robust payment rates. Conversely, customers with lower credit scores are experiencing declining payment rates and increasing borrowing due to heightened inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it seeks stabilization in inflation towards its 2% target before considering any rate cuts.
Despite the prevailing concerns about potential defaults later this year, Mulberry noted that defaults have not yet increased to a level indicative of a consumer crisis. He is particularly monitoring the distinction between homeowners and renters from the pandemic period.
While interest rates have surged, many homeowners secured low fixed rates on their mortgages, insulating them from immediate financial pain. In contrast, renters, who did not benefit from such low rates, are feeling the squeeze, especially with national rents rising over 30% and grocery costs increasing by 25% between 2019 and 2023.
Currently, the overall takeaway from the latest earnings reports is that there hasn’t been any significant new information regarding asset quality. In fact, robust revenues, profits, and strong net interest income point to a healthy banking sector.
Mulberry expressed relief at the stability within the financial system, although cautioned that prolonged high interest rates could intensify stress in the future.