As interest rates reach their highest levels in over 20 years and inflation continues to pressurize consumers, major banks are bracing for increased risks in their lending activities.
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 the funds banks set aside to cover potential losses related to credit risks, including delinquent debts and commercial real estate loans.
Specifically, 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 reached a total of $21.8 billion at the end of the quarter, more than tripling its reserves from the previous quarter. Meanwhile, Wells Fargo’s provisions amounted to $1.24 billion.
These heightened reserves indicate that banks are preparing for a more uncertain financial landscape, where both secured and unsecured loans could lead to significant losses. A recent New York Fed analysis revealed that Americans currently owe a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards, along with rising delinquency rates, is becoming more prevalent as individuals exhaust their pandemic savings and increasingly depend on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where the total exceeded the trillion-dollar threshold, according to TransUnion. Additionally, the commercial real estate sector is facing considerable challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted the ongoing effects of the COVID era, particularly regarding banking and consumer health, which were influenced by significant government stimulus.
However, potential banking challenges are anticipated in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that the quarterly provisions do not perfectly mirror credit quality from the past three months; rather, they reflect banks’ expectations for future conditions.
Narron elaborated that the current economic outlook suggests slowing growth, increased unemployment, and projected interest rate cuts later this year, which could lead to a rise in delinquencies and defaults as the year ends.
Citigroup’s Chief Financial Officer Mark Mason highlighted concerning trends, particularly among lower-income consumers who have seen their savings decline since the pandemic. He stated that while the overall U.S. consumer remains resilient, there are noticeable differences in financial performance across various income segments.
Notably, only the highest income quartile has managed to increase their savings since early 2019, while those with lower credit scores are facing greater financial challenges due to rising inflation and interest rates.
The Federal Reserve currently maintains interest rates at a 23-year high of 5.25-5.5%, awaiting a stabilization of inflation towards its 2% target before considering rate cuts.
Despite banks preparing for potential defaults in the latter half of the year, Mulberry observed that defaults are not escalating at a level indicative of a consumer crisis. He noted the contrasting situations between homeowners and renters, emphasizing that homeowners, who secured low fixed rates during the pandemic, are less affected by current rate hikes compared to renters facing increased housing costs.
Recent earnings reports reveal no significant changes in asset quality. Strong revenues, profits, and solid net interest income continue to suggest a healthy banking sector. Mulberry concluded that while the financial system remains robust, the longer elevated interest rates persist, the more pressure it will exert on consumers and banks alike.