As interest rates remain at their highest level in over two decades and inflation continues to impact consumers, major banks are preparing for potential risks linked to their lending practices. In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses. These provisions refer to funds set aside by banks to cover anticipated losses from credit risks, including delinquent accounts and lending, particularly in commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s total allowance for credit losses rose to $21.8 billion, more than tripling its previous quarter provision. Wells Fargo reported provisions amounting to $1.24 billion.
This increase in provisions indicates that banks are bracing themselves for a more challenging environment where both secured and unsecured loans could lead to greater losses. A recent report from the New York Fed revealed that U.S. households carry a total debt of $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards and subsequently rising delinquency rates are becoming more prominent as consumers deplete their pandemic-era savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total balances surpassed this threshold, according to TransUnion. The commercial real estate sector continues to face uncertainties as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, stated, “We’re still coming out of this COVID era, and particularly concerning the health of consumers, it was the stimulus measures that were enacted to support them.”
Looking ahead, experts warn of potential troubles for banks in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that the provisions reported by banks may not fully reflect credit quality for the recent quarter, but rather their expectations for future conditions.
Narron mentioned that banks anticipate a slowdown in economic growth, higher unemployment, and two expected interest rate cuts in September and December of this year, which could lead to increased delinquency and defaults by year-end.
Citigroup’s chief financial officer, Mark Mason, highlighted that troubles appear to be concentrated among lower-income consumers whose savings have diminished since the pandemic began. He remarked, “While the overall U.S. consumer remains resilient, we see performance disparity across income groups and credit scores.”
Currently, only consumers in the highest income quartile have more savings compared to pre-pandemic levels, while customers with FICO scores above 740 are driving spending growth and maintaining high payment rates. In contrast, those in lower FICO brackets are experiencing more pronounced declines in payment rates and are borrowing more due to the pressures of rising inflation and interest rates.
The Federal Reserve continues to keep interest rates at a 23-year high range of 5.25-5.5% as it waits for inflation to stabilize around its 2% target before implementing anticipated rate cuts.
Despite banks bracing for an increase in defaults later this year, Mulberry indicated that defaults are not currently rising to levels indicative of a consumer crisis. He is particularly interested in comparing outcomes between homeowners and renters during the pandemic. Mulberry noted that homeowners locked in low fixed rates on their debts, thus shielding them from the current pain of rising rates, whereas renters have faced significant rent increases, compounded by slower wage growth.
In summary, the latest earnings reports suggest that while banks are maintaining solid revenues, profits, and net interest income, the financial sector continues to exhibit resilience. Mulberry emphasized that the longer high interest rates persist, the more pressure they may place on consumers and the broader banking sector.