As interest rates remain at their highest levels in over two decades and inflation continues to impact 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 all raised their credit loss provisions compared to the previous quarter. These provisions serve as financial safety nets to cover potential losses stemming from credit risks, including overdue or non-performing loans, particularly in the commercial real estate sector.
JPMorgan set aside $3.05 billion for credit losses during 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, significantly increasing from the previous quarter’s reserve. Wells Fargo also reported $1.24 billion in provisions.
This increase in reserves indicates that banks are preparing for a more challenging financial landscape, where both secured and unsecured loans may generate larger losses. A recent study by the New York Federal Reserve indicated that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise, as individuals exhaust their savings accumulated during the pandemic and increasingly rely on credit. According to TransUnion, credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total cardholder balances surpassed the trillion-dollar threshold. The commercial real estate sector is also facing significant challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the lasting effects of the COVID-era stimulus measures on banking and consumer health.
However, any significant issues for banks are expected in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that the provisions reported in any given quarter do not necessarily reflect the recent credit quality but rather what banks anticipate will happen in the future.
The banks are forecasting a slowdown in economic growth, rising unemployment, and two interest rate cuts anticipated later this year. These factors could lead to more delinquencies and defaults as the year progresses.
Citigroup’s CFO Mark Mason highlighted concerning trends among lower-income consumers, who have seen their savings diminish since the pandemic. While the overall U.S. consumer remains resilient, there is a noticeable disparity in financial behaviors across income and credit score levels.
He noted that only the highest income quartile has more savings than they did in early 2019, with spending growth and timely payments largely driven by consumers with a FICO score of over 740. Conversely, those with lower FICO scores are experiencing declining payment rates and increasing borrowing as they grapple with high inflation and interest rates.
The Federal Reserve has maintained interest rates between 5.25% and 5.5%, the highest in 23 years, as it awaits inflation to stabilize around its 2% target before implementing expected rate cuts.
Despite banks preparing for increased defaults in the latter half of the year, current default rates do not point to an immediate consumer crisis. Mulberry observed a divide between homeowners and renters during the pandemic, with homeowners benefiting from low fixed rates on their debts, while renters, facing rising rents—over 30% nationwide since 2019—and grocery costs—up 25% in the same timeframe—are experiencing greater budgetary pressure.
Overall, the recent earnings reports reveal no new concerns regarding asset quality, with strong revenues and profits indicating a resilient banking sector. Mulberry emphasized that while the banking system remains robust, sustained high interest rates could lead to more strain in the future.