As interest rates reach levels not seen in over 20 years and inflation pressures persist, major banks are adjusting to potential risks in their lending strategies.
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 funds that banks set aside to manage potential losses related to credit risk, which includes non-performing loans and commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses; Bank of America allocated $1.5 billion; Citigroup raised its allowance for credit losses to $21.8 billion, more than tripling its reserve from the prior quarter; and Wells Fargo reported provisions of $1.24 billion.
These reserve increases indicate that banks are preparing for a more challenging financial landscape, where both secured and unsecured loans could lead to significant losses. A recent report from the New York Fed revealed that Americans hold a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are climbing as individuals deplete their pandemic-era savings and turn to credit more frequently. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where they surpassed the trillion-dollar threshold. The commercial real estate sector remains particularly vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, highlighted that the banking industry’s current situation is a residual effect of the COVID-19 pandemic, noting that stimulus efforts have significantly influenced consumer health.
Experts warn that challenges for banks may arise in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that reserves reflect banks’ future expectations, which can differ from recent credit quality outcomes.
Currently, banks anticipate slower economic growth, higher unemployment, and potential interest rate cuts in September and December, which may lead to increased delinquencies and defaults as the year ends.
Citi’s CFO Mark Mason pointed out that the financial stress is primarily affecting lower-income consumers, who have experienced a decline in savings since the pandemic’s peak. He noted that while the overall U.S. consumer remains resilient, there are significant disparities in spending and payment behaviors across different income levels.
Mason stated that only the highest income quartile has managed to increase savings since early 2019, while those in lower FICO score brackets are facing greater financial strain due to inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25% to 5.5%, awaiting signs of stabilizing inflation before enacting anticipated rate cuts.
Despite preparations for increased defaults later this year, Mulberry observed that current default rates do not signal an impending consumer crisis. He is particularly interested in the contrast between homeowners and renters during the pandemic; homeowners secured low fixed rates, thus experiencing less financial distress, while renters face rising costs without similar advantages.
Over the last few years, rental prices have surged by over 30%, and grocery prices have increased by 25%, burdening renters more than homeowners, as wage growth has not kept pace.
For the time being, the key takeaway from recent earnings reports is that there have been no significant changes in asset quality, according to Narron. Strong revenue, profit, and interest income figures suggest the banking sector remains robust.
Mulberry concluded that while there is significant strength within the banking system, ongoing high interest rates could lead to increased stress in the future.