As interest rates reach levels not seen in over two decades and inflation continues to impact consumers, major banks are preparing for increased risks associated with their lending practices.
In the second quarter, leading financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions represent funds set aside to cover potential losses from credit risks, including bad debts and loans like commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses, while Bank of America allocated $1.5 billion. Citigroup’s credit loss allowance rose to $21.8 billion, more than tripling its reserves from the previous quarter, and Wells Fargo allocated $1.24 billion for provisions.
This increase in reserves indicates that banks are bracing for a more challenging lending environment, where both secured and unsecured loans may lead to greater losses. Recent analysis by the New York Federal Reserve revealed that American households owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Amidst waning pandemic-era savings, credit card issuance and delinquency rates are also on the rise. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where they exceeded the trillion-dollar threshold, according to TransUnion. Additionally, the commercial real estate sector is facing instability.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the ongoing effects of the COVID-19 pandemic and the stimulus measures have greatly influenced consumer banking health.
However, any challenges for banks are expected to emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions reflect banks’ future expectations rather than recent credit quality.
Narron indicated that banks anticipate slowing economic growth, higher unemployment rates, and potential interest rate cuts later this year, which could lead to more delinquencies and defaults as the year progresses.
Citi’s chief financial officer, Mark Mason, highlighted that the financial strain appears to be concentrated among lower income consumers, who have seen their savings diminish since the pandemic.
Despite an overall resilient consumer market, Mason noted disparities in financial performance across different income levels. He pointed out that only the highest income quartile has maintained or increased savings since 2019, while lower FICO score customers are experiencing decreased payment rates and increased borrowing due to high inflation and interest rates.
The Federal Reserve has maintained interest rates at a level between 5.25% and 5.5%, the highest in 23 years, as it awaits signs of inflation stabilizing towards its 2% target before implementing any rate cuts.
While banks are bracing for potential defaults, Mulberry stated that current default rates do not suggest an impending consumer crisis. He noted that homeowners from the pandemic era have locked in low fixed rates, thus minimizing their financial discomfort, whereas renters, who missed that opportunity, face rising rental costs impacting their budgets significantly.
Overall, the recent earnings reports revealed no significant changes in asset quality, with strong revenues, profits, and steady net interest income suggesting continued health within the banking sector. Mulberry expressed relief over the ongoing strength of the financial system but emphasized that sustained high interest rates will continue to exert pressure on the economy.