As interest rates rise to over two-decade highs and inflation continues to impact consumers, major banks are bracing themselves for increased risks linked to their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all reported raising their provisions for credit losses compared to the previous quarter. These provisions represent the funds set aside by financial institutions to cover potential losses related to credit risks, including defaults and issues surrounding commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s credit loss allowance reached $21.8 billion, significantly increasing from the previous quarter, and Wells Fargo’s provisions totaled $1.24 billion.
These increased provisions indicate that banks are preparing for a more volatile environment, where both secured and unsecured loans are likely to lead to larger losses for some of the country’s largest banks. A recent report by the New York Fed highlighted that American households collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Additionally, the issuance of credit cards and delinquency rates are also rising as individuals increasingly rely on credit once their pandemic-era savings have begun to dwindle. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where total cardholder balances exceeded the trillion-dollar threshold. Moreover, the CRE sector remains under significant pressure.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the pharmaceutical and consumer sectors are still recovering from the COVID era, primarily due to the stimulus measures that were previously implemented.
However, experts warn that challenges for banks may arise in the future. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported by banks do not necessarily indicate the quality of credit in the last three months, but rather reflect their expectations for the future.
As banks look ahead, they anticipate a slowdown in economic growth, a rise in unemployment, and potential interest rate cuts later this year. This outlook suggests there may be an increase in delinquencies and defaults as the year comes to a close.
Citi’s chief financial officer, Mark Mason, acknowledged that warning signs are becoming more apparent among lower-income consumers, who have seen their savings diminish since the pandemic. He noted a divergence in consumer performance and behavior, with only those in the highest income brackets maintaining increased savings since early 2019. Customers with high FICO scores are driving spending growth, while those with lower scores are struggling to keep up with inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation rates toward the central bank’s target of 2% before considering any cuts.
Despite banks bracing for higher default rates in the latter half of the year, the current rate of defaults does not indicate an impending consumer crisis, according to Mulberry. He emphasized the distinction between homeowners who secured low fixed rates during the pandemic and renters, who missed that opportunity.
With rents rising over 30% nationwide from 2019 to 2023 and grocery costs increasing by 25% during the same period, renters are facing significant strain on their budgets compared to homeowners.
Overall, the latest earnings reports indicate that asset quality has not worsened. The banking sector continues to show signs of strength, including robust revenues and profits, which suggests resilience in the current financial environment. Mulberry stated that while the banking sector remains strong, it is crucial to monitor the potential stress caused by elevated interest rates over time.