With interest rates reaching their highest levels in over two decades and inflation continuing to impact consumers, major banks are bracing for increased risks associated with their lending activities.
In a recent report, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their credit loss provisions in the second quarter compared to the previous quarter. These provisions are crucial as they represent the funds set aside by banks to cover potential losses from credit risks, including defaults on loans and bad debt.
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 soared to $21.8 billion, reflecting a more than tripling of its reserves from the previous quarter, and Wells Fargo reported provisions of $1.24 billion.
These heightened provisions indicate that banks are anticipating a challenging environment, where both secured and unsecured loans may lead to larger losses. A recent New York Fed analysis revealed that American households owe a staggering $17.7 trillion in various loans, including consumer and student loans and mortgages.
Moreover, credit card issuance and delinquency rates are rising as consumers deplete savings accumulated during the pandemic 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 overall cardholder balances surpassed the trillion-dollar threshold, according to data from TransUnion. Additionally, the commercial real estate sector is facing significant uncertainties.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented, “We’re still coming out of this COVID era, especially regarding banking and the consumer’s health, largely influenced by the stimulus provided to consumers.”
However, analysts predict that issues for banks may become more apparent in the coming months. Mark Narron, a senior director at Fitch Ratings, explained, “The provisions reflected in any given quarter don’t solely represent credit quality from the past three months but rather what banks anticipate will occur in the future.”
Currently, banks expect economic growth to slow, unemployment rates to rise, and foresee potential interest rate cuts in September and December. This outlook suggests that delinquencies and defaults could increase as the year progresses.
Citi’s chief financial officer, Mark Mason, highlighted concerns regarding lower-income consumers, who have seen their savings diminish since the pandemic. “While the overall U.S. consumer remains resilient, we are observing divergent performance and behavior across different income levels,” Mason stated during a call with analysts. He noted that only the top income quartile has maintained or increased their savings since early 2019, while those in lower FICO score categories are experiencing greater financial strain due to high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high between 5.25% and 5.5%, waiting for inflation levels to stabilize near the target of 2% before enacting anticipated rate cuts.
Despite banks preparing for potential defaults, current data does not indicate a looming consumer crisis, according to Mulberry. He pointed out the contrast between homeowners who secured low fixed-rate mortgages and renters who have faced significantly rising rental prices. “Homeowners locked in very low fixed rates on their debt, so they are not feeling the pressure as much,” he noted. Conversely, renters are facing challenges amid rising rents that have significantly outpaced wage growth.
For now, the earnings reports reveal “nothing new this quarter regarding asset quality,” according to Narron. He notes that robust revenues, profits, and stable net interest income are positive signs for the banking sector’s health. Mulberry emphasized, “The banking sector displays strength that was somewhat anticipated, and it suggests that the financial system remains strong and sound. However, we are closely monitoring the situation, as prolonged high interest rates will inevitably lead to increased stress.”