As interest rates reach their highest levels in over two decades and inflation continues to impact consumers, major banks are gearing up for increased risks associated with their lending practices.
In the second quarter, major financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo significantly increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside to cover potential losses from credit risks, which can include delinquent accounts and commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, marking more than a tripling of its reserves from the previous quarter. Wells Fargo’s provisions totaled $1.24 billion.
These increased reserves signal that banks are preparing for a more challenging lending environment, where both secured and unsecured loans might result in higher losses. According to a recent analysis by the New York Federal Reserve, Americans currently owe about $17.7 trillion in various types of consumer debt, including student loans and mortgages.
The rise in credit card issuance and corresponding delinquency rates suggests that consumers are depleting their pandemic-era savings and increasingly relying on credit. 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, stated that the lingering effects of the COVID era, particularly the stimulus distributed to consumers, are still felt within the banking system and consumer health.
However, challenges for banks are expected to unfold over the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions set by banks do not merely reflect past credit quality but rather their expectations for future economic conditions.
In the short term, banks are anticipating slower economic growth, increased unemployment, and potential interest rate cuts later this year. This outlook raises the possibility of greater delinquencies and defaults as the year progresses.
Citi’s Chief Financial Officer, Mark Mason, indicated that the concerns are primarily affecting lower-income consumers, who have seen their savings diminish since the pandemic began. He pointed out that while the overall U.S. consumer remains resilient, performance and behavior vary significantly across different income levels and credit scores.
According to Mason, only the highest income quartile currently holds more savings than they did in early 2019, with those having credit scores above 740 driving spending growth and maintaining robust payment rates. In contrast, those in lower credit score brackets are experiencing a decline in payment rates and are borrowing more as inflation and high interest rates take a toll.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25 to 5.5% as it waits for inflation to stabilize toward its target of 2% before implementing anticipated rate cuts.
Despite banks bracing for potential higher default rates later in the year, Mulberry notes that current default rates do not indicate an imminent consumer crisis. He highlights a distinction between homeowners and renters during the pandemic. Homeowners, who secured low fixed-rate mortgages, are less affected by the current rate hikes, while renters face increasing housing costs and limited wage growth, putting significant strain on their budgets.
In summary, the latest earnings reports suggest that the banking sector remains stable, with no new asset quality concerns reported this quarter. Strong revenues, profits, and net interest income indicate that the banks are still in a healthy position, although vigilance continues as sustained high interest rates could induce further stress on the sector.