With interest rates at their highest levels in over two decades and ongoing inflation impacting consumers, major banks are preparing to navigate increased risks linked to their lending activities.
In the second quarter of this year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions are reserves set aside by banks to offset potential losses due to credit risks, including defaults on loans and issues with commercial real estate.
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 soared to $21.8 billion, more than three times its reserve increase from the previous quarter. Wells Fargo accounted for $1.24 billion in provisions.
These reserve increases indicate that banks are bracing for a more challenging lending environment, where both secured and unsecured loans could lead to greater losses for some of the country’s largest financial institutions. A recent analysis from the New York Fed revealed that Americans owe approximately $17.7 trillion collectively in consumer loans, student loans, and mortgages.
As pandemic-era savings dwindle, credit card usage and delinquency rates are on the rise. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances exceeded the trillion-dollar mark, according to TransUnion. Additionally, commercial real estate remains in a precarious situation.
Brian Mulberry, a portfolio manager at Zacks Investment Management, pointed out that the current banking landscape is still recovering from the effects of the pandemic, which was buoyed by significant stimulus aimed at consumers.
However, potential issues for banks may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, stated that the provisions reported in any quarter may not accurately reflect the credit quality of loans made in the previous three months; rather, they signal banks’ expectations for future credit conditions.
As banks foresee a slowdown in economic growth, rising unemployment, and interest rate cuts in September and December, there may be an increase in delinquencies and defaults as the year progresses.
Citi’s CFO Mark Mason noted that the concerning trends are more pronounced among lower-income consumers whose savings have diminished since the pandemic. While the overall U.S. consumer remains resilient, performance and behavior vary significantly based on income levels and credit scores. Higher-income consumers continue to have more savings compared to their pre-pandemic levels, while those in lower income brackets are experiencing marked increases in borrowing and declines in payment rates due to high inflation and interest rates.
The Federal Reserve maintains interest rates at a 23-year high of 5.25-5.5%, waiting for inflation to stabilize around its 2% target before considering anticipated rate cuts.
Despite banks bracing for potential defaults, Mulberry remarks that defaults have not yet escalated enough to signal a consumer crisis. He underscores the distinction between homeowners, who locked in low fixed rates during the pandemic, and renters, who have faced significant increases in rent and costs, putting more strain on their budgets.
Currently, the earnings reports indicate no significant deterioration in asset quality, with strong revenue and profits suggesting the banking sector remains robust. Mulberry emphasized the ongoing strength of the financial system but cautioned that prolonged high interest rates could lead to increased stress in the future.