As interest rates reach their highest levels in over two decades and inflation continues to affect consumers, major banks are taking precautionary measures to address potential risks in their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their reserves for credit losses compared to the previous quarter. These reserves represent funds set aside by financial institutions to cover potential losses related to credit risks, including delinquent loans and risks linked to commercial real estate (CRE).
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 reached $21.8 billion, significantly up from the previous quarter, and Wells Fargo designated $1.24 billion.
These increased reserves reflect banks’ preparations for a potentially riskier lending environment, as both secured and unsecured loans may lead to larger losses. A recent analysis by the New York Fed indicated that Americans collectively owe $17.7 trillion in consumer loans, including student loans and mortgages.
The issuance of credit cards and the subsequent rise in delinquency rates are also notable, as individuals increasingly depend on credit as their pandemic savings diminish. Credit card balances climbed to $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances exceeded the trillion-dollar threshold, according to TransUnion. The status of CRE loans also remains uncertain.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, pointed out that the ongoing recovery from the pandemic significantly influences the banking sector and consumer health, largely due to stimulus measures provided to consumers.
However, challenges for banks may arise in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that the provisions made by banks don’t solely reflect recent credit quality but rather their expectations for future circumstances.
Currently, banks are anticipating slower economic growth, rising unemployment rates, and two expected interest rate cuts later this year in September and December, which could lead to an increase in delinquency and default rates before the year ends.
Citigroup’s chief financial officer Mark Mason acknowledged that the warning signs appear predominantly among lower-income consumers, who have experienced a decline in savings since the pandemic.
“While we continue to see an overall resilient U.S. consumer, we also continue to see a divergence in performance and behavior across FICO and income levels,” Mason stated during a recent analyst call. He emphasized that only the highest income quartile has maintained more savings than at the start of 2019, whereas lower FICO score customers are facing significant pressure from rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25%-5.5%, awaiting stabilization of inflation measures toward the central bank’s 2% target before implementing anticipated rate cuts.
Despite banks gearing up for potential defaults in the latter part of the year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He is particularly interested in the contrasting situations of homeowners versus renters during the pandemic.
Though interest rates have increased significantly, homeowners secured low fixed rates during that time and are not feeling the financial strain as severely as renters, who have faced substantial rent and grocery price hikes since 2019.
Overall, the latest earnings results reveal that there have been no new concerns regarding asset quality. Strong revenues, profits, and sustained net interest income suggest the banking sector remains robust. Mulberry commented that there is notable strength in the banking sector, affirming that the current financial system remains stable, although prolonged high interest rates could create additional stress.