As interest rates remain at their highest levels in over twenty years and inflation continues to pressure consumers, major banks are bracing 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 represent the funds set aside by financial institutions to cover potential losses due to credit risks, such as delinquent debt and bad loans, including exposures to commercial real estate.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses rose to $21.8 billion by the end of the quarter, a substantial increase from the prior period, and Wells Fargo marked its provisions at $1.24 billion.
These increases signal that banks are preparing for a more challenging financial environment, where both secured and unsecured loans could lead to significant losses. A recent report from the New York Federal Reserve highlighted that Americans collectively owe $17.7 trillion across various forms of consumer debt, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as consumers deplete their pandemic-era savings and turn increasingly to credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that totals surpassed the trillion-dollar threshold, according to TransUnion. Additionally, commercial real estate remains in a vulnerable position.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted that the economy is still recovering from the COVID-19 pandemic, largely due to the stimulus measures provided to consumers.
Looking ahead, potential issues for banks may emerge in the upcoming months. Mark Narron, a senior director at Fitch Ratings, explained that quarterly provisions do not solely reflect recent credit quality but are instead based on banks’ expectations for future performance.
The banks foresee slower economic growth, a rise in the unemployment rate, and two anticipated interest rate cuts later this year, which could lead to increased delinquencies and defaults as the year concludes.
Citi’s Chief Financial Officer Mark Mason pointed out that these warning signs are primarily evident among lower-income consumers, who have experienced a decrease in savings since the pandemic.
Although the U.S. consumer’s overall resilience is noted, there is a notable disparity in financial behavior across different income levels and credit profiles. Mason indicated that only the highest-income quartile has more savings than they did in early 2019, while those in lower FICO score categories are struggling with rising expenses and are borrowing more.
The Federal Reserve is maintaining interest rates between 5.25% and 5.5%, the highest in 23 years, as it waits for inflation to stabilize around its target of 2% before making anticipated cuts.
Despite banks preparing for higher default rates in the latter half of the year, Mulberry emphasized that defaults have not yet escalated to a level indicative of a consumer crisis. He highlighted the differing situations of homeowners and renters, noting that those who purchased homes during the pandemic took on low fixed-rate mortgages, while renters face significant challenges as rental costs have surged over 30% since 2019, outpacing wage growth.
Overall, the recent earnings reports indicated that there were no significant new concerns regarding asset quality. According to Narron, robust revenues, profits, and resilient net interest income are encouraging signs that the banking sector remains stable.
Mulberry concluded that while there is strength in the banking sector, it is crucial to monitor the situation closely, as prolonged high interest rates could exacerbate financial stress.