As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are gearing up for increased risks associated with 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 are funds that banks allocate to cover potential losses related to credit risk, including delinquent debts and various loans, such as commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America reserved $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, more than tripling its buildup from the prior quarter, and Wells Fargo allocated $1.24 billion for similar purposes.
These increased reserves indicate that banks are preparing for a more challenging economic environment, where both secured and unsecured loans could result in greater losses. A recent analysis by the New York Fed revealed that American households currently owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are rising as consumers exhaust their pandemic-era savings and increasingly rely on credit. In the first quarter of this year, credit card balances exceeded $1 trillion for the second consecutive quarter, according to TransUnion. The CRE market remains vulnerable as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector and consumer health are still adjusting to the post-COVID environment, largely due to the stimulus measures implemented during that period.
However, any potential issues for banks may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, emphasized that the provisions banks report each quarter are more indicative of their expectations for future credit quality rather than reflecting immediate past performance.
Currently, banks anticipate slower economic growth, higher unemployment rates, and forecast two interest rate cuts in September and December, which could lead to increased delinquencies and defaults toward the end of the year.
Citi’s Chief Financial Officer Mark Mason pointed out concerning trends among lower-income consumers, who have experienced dwindling savings since the pandemic. He remarked that only the highest income quartile has greater savings compared to the start of 2019, with those in the top 740 FICO score bracket driving spending and payment consistency. Conversely, individuals with lower FICO scores are experiencing sharper declines in payment rates 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 awaits stabilization in inflation to reach its 2% target before executing anticipated rate cuts.
Despite banks bracing for a rise in defaults later this year, Mulberry asserted that currently, defaults are not increasing at alarming rates that suggest a consumer crisis. He noted that homeowners, having locked in low fixed rates, are not feeling the impact of rising costs to the same extent as renters. Since 2019, rents have surged over 30% nationwide, and grocery prices have increased by 25%, putting significant financial strain on renters without the benefit of locked-in lower costs.
Overall, the latest earnings reports indicate no new issues regarding asset quality. Strong revenues, profits, and robust net interest income suggest that the banking sector remains healthy. Mulberry expressed relief in observing that the financial system’s structures remain resilient, although long-term high interest rates will likely intensify pressure on consumers.