With interest rates reaching their highest levels in over 20 years and inflation continuing to pressure consumers, major banks are bracing for increased risks in their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their reserves for credit losses compared to the previous quarter. These reserves are funds set aside by banks to cover potential losses from credit risks, including delinquent debts and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses grew to $21.8 billion, marking a significant increase from the previous quarter. Wells Fargo contributed $1.24 billion to its provisions.
This increase in reserves indicates that banks are preparing for a riskier lending environment, where both secured and unsecured loans may lead to greater losses. A recent study from the New York Federal Reserve reported that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are rising as people deplete their pandemic-era savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, continuing a trend of surpassing the trillion-dollar mark for the second consecutive quarter, as reported by TransUnion. Furthermore, commercial real estate remains in a vulnerable state.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking sector remains influenced by consumer health stemming from stimulus measures administered during the COVID era.
However, any challenges for banks are anticipated in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that the provisions reported in any given quarter do not necessarily reflect the credit quality of the prior three months but rather the banks’ expectations for the future.
Banks are predicting slower economic growth, an increasing unemployment rate, and potential interest rate cuts later this year. This outlook suggests there could be more delinquencies and defaults by the end of the year.
Mark Mason, chief financial officer at Citigroup, highlighted that the warning signs are particularly pronounced among lower-income consumers, who have seen their savings decline post-pandemic. He emphasized a disparity in financial resilience among different income groups, noting that only the highest income quartile has retained more savings since the start of 2019.
While the Federal Reserve has maintained interest rates at a 23-year high between 5.25% and 5.5%, they are waiting for inflation to stabilize around the target of 2% before considering anticipated rate cuts.
Despite expectations of increased defaults, current trends do not indicate an imminent consumer crisis, according to Mulberry. He is particularly observing the financial situation of homeowners versus renters. Homeowners who secured low fixed rates are reportedly less affected by rising costs, while renters, facing rental price increases of over 30% since 2019 without the benefit of fixed rates, may experience greater financial stress.
Even with banks gearing up for potential defaults in the latter half of the year, the latest earnings reports do not suggest any major new concerns regarding asset quality. Positive indicators such as robust revenues, profits, and strong net interest income suggest that the banking sector remains healthy. Mulberry noted the resilience of the financial system and underscored the need to monitor how long elevated interest rates persist, given their potential to induce stress.