With interest rates at their highest levels in over 20 years and inflation impacting consumers, major banks are gearing up to confront increased risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo elevated their provisions for credit losses compared to the previous quarter. These provisions represent funds set aside by financial institutions to mitigate potential losses arising from credit risks, such as delinquent debts and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter, Bank of America set aside $1.5 billion, Citigroup’s total allowance reached $21.8 billion, significantly increasing its reserves from the previous quarter, and Wells Fargo’s provisions totaled $1.24 billion.
These increased reserves indicate that banks are preparing for a potentially riskier financial environment, where both secured and unsecured loans could lead to larger losses. A recent analysis by the New York Federal Reserve revealed that American consumers collectively owe $17.7 trillion across various types of loans, including consumer and student loans as well as mortgages.
Additionally, there has been a rise in credit card issuance and delinquency rates as consumers deplete their savings from the pandemic and increasingly rely on credit. In the first quarter, credit card balances reached $1.02 trillion, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector remains vulnerable as well.
Brian Mulberry from Zacks Investment Management emphasized that the banking sector is still recovering from the impacts of the COVID-19 pandemic, particularly influenced by the stimulus measures that supported consumers during that time.
Experts suggest that potential issues for banks may develop in the months to come. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported in any given quarter reflect banks’ expectations about future credit quality rather than past performance.
The current economic outlook suggests slower growth, increased unemployment rates, and anticipated interest rate cuts in September and December, which could lead to an uptick in delinquencies and defaults as the year progresses.
Citigroup’s CFO Mark Mason highlighted concerns concentrated among lower-income consumers who have seen their savings diminish since the pandemic. While the overall U.S. consumer remains resilient, performance varies significantly across income and credit score segments.
He noted that only the highest income quartile has experienced an increase in savings since 2019, with higher credit score customers leading spending growth and maintaining payment rates. In contrast, customers with lower credit scores are facing reduced payment rates and increasing debt burdens due to the strain of rising inflation and interest rates.
The Federal Reserve maintains interest rates in the 5.25%-5.5% range, the highest in 23 years, as it awaits stabilization of inflation measures towards the target rate of 2% before implementing anticipated rate cuts.
Despite banks preparing for a potential rise in defaults later this year, current default rates are not indicative of a broader consumer crisis, according to Mulberry. He noted that a key point of observation is the contrast between homeowners and renters during the pandemic.
Homeowners benefited from historically low fixed-rate mortgages, while renters have been disproportionately affected by rising rental costs and inflation. Rent prices have surged over 30% nationwide since 2019, and grocery prices have increased by 25%, placing substantial financial pressure on renters who lack the protection of locked-in low rates.
For now, industry analysts indicate that the latest earnings reports revealed no surprising changes in asset quality. Strong revenues, profits, and robust net interest income suggest that the banking sector remains healthy.
Overall, Mulberry noted a resilient banking system, a reassuring sign considering the challenges posed by persistent high-interest rates. However, he cautioned that sustained elevated rates could lead to increased stress in the financial system moving forward.