As interest rates reach levels not seen in over two decades and inflation pressures consumers, major banks are gearing up to manage potential risks arising from 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 mitigate losses from credit risks, which include defaults on loans and issues with commercial real estate (CRE) lending.
In detail, JPMorgan allocated $3.05 billion for credit losses; Bank of America set aside $1.5 billion; Citigroup’s allowance surged to $21.8 billion, more than triple its previous quarter’s reserves; and Wells Fargo reported $1.24 billion in provisions.
The increased reserves signal that banks are preparing for a more challenging financial environment, where both secured and unsecured loans might incur significant losses. A recent analysis from the New York Fed estimated that American households owe a staggering $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card issuance is also rising alongside delinquency rates, as consumers exhaust their savings accumulated during the pandemic and increasingly rely on credit. According to TransUnion, credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that the total surpassed the trillion-dollar mark. The commercial real estate sector continues to face uncertainty as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the aftermath of COVID-19 and the associated consumer stimulus heavily influence the current banking landscape.
Moving forward, potential problems for banks are anticipated in the upcoming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, explained that quarterly provisions do not solely reflect recent credit quality but rather banks’ expectations for future performance.
He pointed out that the economic outlook indicates slowing growth, an increase in unemployment, and anticipated interest rate cuts this September and December, which could lead to higher delinquency and default rates by year-end.
Citi’s chief financial officer, Mark Mason, observed warning signs particularly among lower-income consumers, who have seen their savings diminished since the pandemic. He highlighted a growing divide in financial behavior across different income levels and credit scores.
Mason stated that only the highest income quintile has managed to maintain more savings compared to early 2019. It is primarily consumers with high credit scores who are driving spending growth, while those with lower scores are experiencing significant declines in payment rates as they borrow more amid rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it awaits stabilization in inflation metrics towards the central bank’s 2% target before considering rate cuts.
Currently, while banks are bracing for increased defaults, they have yet to see a significant rise in default rates indicative of a broader consumer crisis. Mulberry remarked that there is a notable distinction between homeowners and renters during this housing market transition.
He noted that homeowners who secured low fixed interest rates are largely insulated from the current economic pressures, unlike renters who face escalating rental costs, which have surged more than 30% nationwide since 2019, alongside a 25% increase in grocery prices.
In summary, the latest earnings reports suggest that “there was nothing new this quarter in terms of asset quality.” Despite the looming challenges, robust revenues, profits, and strong net interest income indicate that the banking sector remains in a healthy state. “The structures of the financial system are still very strong and sound at this point in time,” Mulberry stated. However, he cautioned that prolonged high interest rates could create increasing stress in the economic landscape.