As interest rates reach their highest levels in over 20 years and inflation pressures continue, major banks are gearing up to encounter increased risks in their lending operations.
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 that banks reserve to cover potential losses from lending risks, including delinquent loans and sectors such as commercial real estate (CRE).
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, a figure that more than tripled from the preceding quarter, and Wells Fargo recorded provisions of $1.24 billion.
These allocations indicate that banks are preparing for a more challenging economic environment, where both secured and unsecured loans may lead to greater financial losses. The New York Fed recently reported that American households collectively owe $17.7 trillion in consumer, student, and mortgage loans.
Furthermore, credit card issuance and delinquency rates are climbing as individuals begin to deplete their pandemic-era savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter in which total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. CRE continues to face significant challenges as well.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the financial landscape is still recovering from the impacts of COVID-19, particularly in terms of banking and consumer health linked to the government stimulus distributed during the pandemic.
However, upcoming challenges for banks may become more pronounced in the months ahead. Mark Narron, a senior director at Fitch Ratings, noted that the provisions reported for any given quarter do not necessarily reflect the credit quality from the past three months but rather the banks’ future expectations.
Narron mentioned that the current economic outlook includes predictions of slower growth, rising unemployment, and anticipated interest rate cuts in September and December, which could result in more delinquencies and defaults by year-end.
Citigroup’s CFO, Mark Mason, highlighted that the signs of distress appear to be concentrated among lower-income consumers, who have seen their savings diminish since the pandemic began. He pointed out that while the overall U.S. consumer remains resilient, notable performance variations exist across different income and credit score brackets.
According to Mason, only the highest income quartile has accumulated more savings than they had in early 2019, with consumers boasting FICO scores above 740 leading spending growth and maintaining high payment rates. Conversely, lower FICO score customers are experiencing significant declines in payment rates and borrowing more, burdened by high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% while awaiting inflation metrics to stabilize around the central bank’s 2% target before considering the anticipated rate cuts.
Despite banks preparing for more defaults later in the year, current rates do not indicate a consumer crisis, according to Mulberry. He emphasized the difference between homeowners, who locked in low fixed rates, and renters, who did not have this opportunity amid rising interest rates.
With rents increasing over 30% nationally from 2019 to 2023 and grocery costs rising 25% in the same timeframe, renters not benefiting from low rates face significant pressure on their budgets.
Nonetheless, a key message from this quarter’s earnings is that there are no alarming issues regarding asset quality. Instead, strong revenues, profits, and robust net interest income are positive signs of a healthy banking sector.
Mulberry acknowledged, “There’s some strength in the banking sector that wasn’t entirely unexpected, but it’s reassuring to see that the financial system remains strong.” However, he warned that prolonged high interest rates could lead to increased strain.