As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing themselves for increased risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all significantly increased their provisions for credit losses compared to the previous quarter. These provisions represent funds set aside by financial institutions to cover potential losses arising from credit risks such as delinquent loans and bad debts, particularly in 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 credit loss allowance reached $21.8 billion at the end of the quarter, more than tripling from the previous quarter, and Wells Fargo established provisions of $1.24 billion.
These increased reserves reflect the banks’ anticipation of a riskier economic environment, where both secured and unsecured loans could lead to greater losses. A recent analysis from the New York Fed revealed that Americans owe approximately $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance is also on the rise, leading to increased delinquency rates as consumers exhaust their pandemic-era savings and increasingly rely on credit. Credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. Furthermore, the situation in CRE remains uncertain.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the current landscape, stating that the ongoing recovery from the COVID era and the significant stimulus provided to consumers have shaped the banks’ outlook.
Experts suggest that potential challenges for banks may arise in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that current provisions do not necessarily indicate recent credit quality but rather reflect banks’ future expectations.
Banks anticipate slowing economic growth and a rise in unemployment, predicting two interest rate cuts later this year. This outlook suggests a possibility of increased delinquencies and defaults as the year progresses.
Citi’s CFO Mark Mason highlighted that warning signs are particularly prevalent among lower-income consumers, who have seen their savings dwindle post-pandemic. While the overall U.S. consumer remains resilient, there are disparities based on income and credit scores.
Mason pointed out that only the top income quartile has maintained more savings than they had in 2019, and consumers with high credit scores are driving spending while sustaining their payment rates. Conversely, those with lower credit scores are facing sharp declines in payment rates and are borrowing more due to the impacts of high inflation and interest rates.
The Federal Reserve has kept interest rates at a two-decade high range of 5.25-5.5%, awaiting stabilization in inflation measures towards its target of 2% before implementing anticipated rate cuts.
Despite the preparations for potential defaults later in the year, Mulberry asserts that the current rate of defaults does not indicate a forthcoming consumer crisis. He is particularly interested in the distinction between homeowners during the pandemic, who benefitted from low fixed rates, and renters, who are now facing financial strain due to rising rental and grocery costs.
Currently, the major takeaway from the latest earnings reports is that there are no new concerns regarding asset quality. Strong revenues and profits, along with healthy net interest income, suggest a solid banking sector, according to Narron. Mulberry echoed this sentiment, emphasizing that while the financial system appears robust, prolonged high interest rates could create increased stress in the future.