As interest rates reach their highest level in over 20 years and inflation continues to impact consumers, major banks are gearing up to confront increased risks associated with their lending activities.
In the second quarter, prominent banks including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions represent funds that banks set aside to cover potential losses related to credit risks, including defaults on loans and delinquent debts.
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 surged to $21.8 billion by the end of the quarter, marking more than a threefold increase from the previous quarter. Wells Fargo reported provisions amounting to $1.24 billion.
These increased provisions indicate that banks are preparing for a more challenging financial landscape, wherein both secured and unsecured loans may lead to greater losses. A recent analysis from the New York Fed revealed that American households carry a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
As pandemic-related savings diminish, credit card use, along with delinquency rates, is on the rise. In the first quarter of this year, credit card balances reached $1.02 trillion, the second consecutive quarter in which overall credit card balances surpassed a trillion dollars, according to TransUnion. Additionally, commercial real estate (CRE) remains in a vulnerable position.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted the ongoing recovery from the COVID pandemic, emphasizing the impact of prior stimulus efforts on consumers and the banking sector.
Experts suggest that any challenges for banks may manifest in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that provisions set aside by banks reflect future expectations rather than current credit quality, marking a shift from historical practices.
In the near term, banks anticipate slower economic growth, an increase in unemployment, and potential interest rate cuts later this year, which could lead to more delinquencies and defaults by the year’s end.
Mark Mason, chief financial officer at Citi, highlighted concerning trends among lower-income consumers, who have seen their savings decrease significantly since the pandemic. He noted that while the overall U.S. consumer appears resilient, there are disparities based on income and credit scores.
Mason explained that only the highest income quartile has more savings than in early 2019, and it is those with high credit scores driving spending growth. Meanwhile, consumers with lower credit scores are experiencing substantial declines in payment rates as they struggle with high inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%. The Fed is awaiting stabilization in inflation measures towards its 2% target before implementing expected rate cuts.
Although banks are bracing for potential defaults in the latter half of the year, current data does not indicate a consumer crisis. Mulberry noted the distinction between homeowners, who locked in low fixed rates during the pandemic, and renters, who are now facing increased financial pressure due to escalating rent costs. Rent prices have surged over 30% nationwide since 2019, while grocery prices have risen by 25%.
Despite ongoing economic pressures, recent earnings reports showed no significant new developments regarding asset quality. Both revenues and profits remain strong, with resilient net interest income signaling a generally healthy banking sector.
Overall, Mulberry observed some strength in the banking sector, alleviating some concerns about financial stability. However, the longer high interest rates persist, the more pressure they are likely to place on the economy.