With interest rates reaching over two-decade highs and inflation continuing to impact consumers, major banks are bracing for increased risks related to their lending practices.
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 are funds set aside by banks to cover potential losses from credit risk, including issues like bad debt and delinquent loans, such as those linked to commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America put aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, marking more than triple its reserve build from the previous quarter. Wells Fargo recorded provisions of $1.24 billion.
These increased provisions indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans could lead to greater losses for some of the nation’s largest banks. A recent report from the New York Fed showed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance is rising, along with delinquency rates, as people deplete their pandemic-era savings and increasingly rely on credit. By the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar mark. Additionally, the commercial real estate sector remains in a vulnerable state.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, explained the current state as still recovering from the COVID era, emphasizing that economic support from stimulus measures has played a significant role in consumer health.
However, any challenges banks may face are expected in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that current provisions typically do not reflect recent credit quality but rather banks’ expectations for the future.
In the near term, banks anticipate a slowdown in economic growth, a rise in unemployment, and two expected interest rate cuts later this year. These conditions could lead to more delinquencies and defaults as the year progresses.
Citigroup’s CFO, Mark Mason, indicated that the concerns are mostly among lower-income consumers, who have seen their savings diminish since the pandemic. He highlighted that only the highest income quartile has maintained more savings than they had at the start of 2019, while customers with lower credit scores are experiencing significant challenges, such as falling payment rates and increased borrowing due to high inflation and interest rates.
The Federal Reserve maintains interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation metrics toward the central bank’s 2% target before proceeding with the anticipated rate cuts.
Despite banks preparing for more defaults as the year closes, current default rates do not indicate a widespread consumer crisis, according to Mulberry. He noted the distinction between homeowners and renters during the pandemic era concerning financial strain, stating that homeowners locked in low fixed rates on their debt and are not feeling the current pressures as intensely as renters, who face rising costs without similar protections.
Overall, the latest earnings reports reveal there are no significant new concerns regarding asset quality. Strong revenues, profits, and robust net interest income suggest the banking sector remains healthy, despite the ongoing effects of high interest rates and inflation stresses. Mulberry emphasized the importance of monitoring the situation, stating that prolonged high interest rates could intensify stress in the economy.