As interest rates reach their highest levels in over two decades and inflation remains a concern for consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo reportedly increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds banks allocate to cover potential losses from credit risks, including delinquent or bad debt and various types of loans, particularly commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, marking more than a threefold increase from the prior quarter, and Wells Fargo recorded provisions of $1.24 billion.
These reserves signal that banks are preparing for a more challenging financial landscape, where both secured and unsecured loans could lead to substantial losses. A recent analysis by the New York Federal Reserve indicated that American households collectively owe $17.7 trillion in consumer, student, and mortgage loans.
The rise in credit card issuance and delinquency rates indicates that consumers are increasingly dependent on credit as their pandemic-era savings deplete. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter that total balances exceeded this threshold, as reported by TransUnion. Additionally, CRE remains in a vulnerable position.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, emphasized that the banking sector is still recovering from the impacts of the COVID-19 pandemic, noting that consumer health has largely benefited from stimulus measures.
However, challenges for banks may arise in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions do not necessarily reflect the credit quality of recent months but instead indicate banks’ expectations for the future.
Banks are anticipating slower economic growth, a rise in unemployment, and potential interest rate cuts later this year, which could lead to more delinquencies and defaults as the year concludes.
Citigroup’s CFO, Mark Mason, observed that economic red flags are primarily evident among lower-income consumers, who have seen their savings diminish post-pandemic.
Mason pointed out a disparity in consumer behavior based on credit scores and income levels, noting that only the highest income quartile has experienced a rise in savings since 2019. He mentioned that consumers with scores over 740 are driving spending growth, whereas those with lower scores are facing declining payment rates amid rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting inflation to steady around the central bank’s 2% target before implementing expected rate cuts.
Despite banks preparing for a potential increase in defaults, Mulberry suggested that the rise in defaults has not yet reached a level indicating a consumer crisis. He highlighted a contrast between homeowners and renters, noting that homeowners who locked in low fixed rates are less impacted by current economic strains.
Renters, however, are experiencing significant financial burden, with rents skyrocketing more than 30% nationwide since 2019, alongside a 25% increase in grocery costs, outpacing overall wage growth.
Currently, the overarching message from the latest earnings reports is that there have been no significant changes in asset quality. Strong revenues, profits, and resilient net interest income are encouraging signs for the banking sector.
Mulberry remarked that there are positive aspects within the banking industry, emphasizing the ongoing strength and stability of the financial system. However, he cautioned that prolonged high interest rates could exacerbate stress in the sector.