As interest rates rise to their highest levels in over 20 years and inflation pressures consumers, major banks are bracing for potential lending risks. In the second quarter, 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 by financial institutions to address potential losses from credit risks, such as delinquency or bad debts, including commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in 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, marking a significant increase from the previous quarter, and Wells Fargo had provisions totaling $1.24 billion.
The increase in reserves indicates that banks are preparing for a more challenging environment, where both secured and unsecured loans may result in higher losses. According to a recent New York Federal Reserve analysis, Americans currently owe a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
Furthermore, credit card issuance and delinquency rates are on the rise as many individuals deplete their pandemic-era savings and begin to rely more heavily on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter in which total cardholder balances surpassed the trillion-dollar threshold, as reported by TransUnion. Additionally, the commercial real estate sector continues to face significant challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector is still adapting as the impact of COVID-19 lingers, particularly concerning consumer financial health and the effects of stimulus measures.
Looking ahead, analysts anticipate that banks may encounter difficulties in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that current provisions do not necessarily reflect recent credit quality but rather banks’ projections about future trends.
The outlook suggests slowing economic growth and an expected rise in unemployment, along with two anticipated interest rate cuts later this year, potentially leading to more delinquencies and defaults by year-end.
Citigroup’s CFO Mark Mason highlighted that these warning signals are primarily seen among lower-income consumers, who have experienced a decline in savings since the pandemic. While the overall U.S. consumer market remains resilient, there are significant performance and behavior variances across different income levels.
According to Mason, only the highest-income quartile has increased their savings since early 2019, and it is primarily higher-FICO score customers who drive spending growth and maintain high payment rates. Conversely, lower-FICO score customers are struggling with falling payment rates and are relying more heavily on credit due to the pressures of rising inflation and interest rates.
The Federal Reserve currently maintains interest rates at a 23-year high of 5.25-5.5%, as it awaits a stabilization in inflation measures towards its 2% target before implementing anticipated rate reductions.
Despite preparations for increased defaults, experts suggest that current defaults are not escalating to the level that would indicate a consumer crisis. Mulberry indicated that there is an interesting distinction between homeowners and renters, noting that while interest rates have risen, many homeowners secured low fixed rates during the pandemic and are thus less affected financially. In contrast, renters have had to confront soaring rents, which have increased over 30% nationwide since 2019, alongside grocery costs rising by 25% in the same period.
Currently, the prevailing sentiment from the latest financial results is that there are no alarming issues regarding asset quality. Strong revenues, profits, and resilient net interest income suggest a robust banking sector. Mulberry commented on the enduring strength of the financial system while cautioning that prolonged high interest rates could intensify stress within the banking industry.