As interest rates reach their highest levels in over 20 years and inflation increasingly affects consumers, large banks are bracing for potential risks associated with their lending practices.
In the second quarter, major financial institutions such as 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 account for possible losses from credit risks, including overdue payments and defaulted loans, particularly in the commercial real estate sector.
Specifically, JPMorgan established a provision of $3.05 billion for credit losses, while Bank of America reported $1.5 billion. Citigroup significantly increased its allowance for credit losses to $21.8 billion, more than tripling its previous reserve, and Wells Fargo added $1.24 billion.
These increases signal that banks are preparing for a riskier financial landscape, where both secured and unsecured loans may lead to higher losses. A recent analysis by the New York Federal Reserve highlighted that American households currently owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as consumers deplete their pandemic savings and increasingly rely on credit. As of the first quarter of this year, total credit card balances reached $1.02 trillion, marking the second consecutive quarter that total cardholder balances exceeded the trillion-dollar threshold. The commercial real estate sector also remains in a vulnerable situation.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector is still recovering from the impacts of the COVID-19 pandemic, largely due to the government stimulus provided to consumers.
However, the challenges for banks are expected to arise in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions recorded in any given quarter do not necessarily reflect credit quality for the previous three months but are instead indicative of what banks anticipate for the future.
Banks are currently forecasting slower economic growth, higher unemployment rates, and potential interest rate cuts in September and December, which could lead to increased delinquencies and defaults as the year comes to a close.
Citigroup’s CFO Mark Mason pointed out that warning signs are especially prevalent among lower-income consumers, who have seen their savings diminish since the pandemic began. He stated that while the overall U.S. consumer remains resilient, there is a notable disparity in performance across different income levels and credit scores.
Analysis shows that only the highest income quartile has more savings than they did at the start of 2019, with those in the top FICO score range driving spending growth and maintaining high payment rates. Conversely, lower credit score customers are experiencing greater declines in payment rates and are turning to borrowing as they struggle with the effects of rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25% to 5.5%, awaiting stabilization in inflation measures towards the central bank’s 2% target before implementing anticipated rate cuts.
Despite banks’ preparations for increased defaults in the latter half of the year, current data does not indicate a consumer crisis, according to Mulberry. He is particularly observing the contrast between homeowners and renters during the pandemic.
Though interest rates have risen significantly, homeowners have largely benefited from low fixed rates on their debts, while renters, who did not have the ability to secure such rates, are facing mounting pressure due to skyrocketing rents and rising grocery costs.
Overall, the latest earnings reports reveal stability in asset quality, with solid revenues, profits, and net interest income showcasing the resilience of the banking sector. Mulberry stated that there are encouraging signs in the financial system, although concerns remain regarding potential stress caused by persistent high interest rates.