With interest rates at their highest level in over 20 years and inflation putting pressure on consumers, major banks are bracing for increased risks associated with their lending activities.
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 represent the funds that banks set aside to cover potential losses from credit risks, including defaults and delinquent loans, particularly in the commercial real estate sector.
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, more than tripling its reserves from the previous quarter, and Wells Fargo reported provisions of $1.24 billion.
The increased reserves indicate that banks are preparing for a challenging environment, where both secured and unsecured loans could lead to greater losses. A recent analysis by the New York Fed highlighted that Americans now collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, the issuance of credit cards and the delinquency rates are climbing as individuals deplete their pandemic-era savings and become more reliant on credit. In the first quarter of this year, credit card balances exceeded $1 trillion for the second consecutive quarter, according to TransUnion. The commercial real estate market also remains vulnerable.
“We’re still emerging from the COVID era, and the consumer’s financial health has been impacted significantly due to the stimulus measures rolled out during that time,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any difficulties for banks may emerge in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, stated that current provisions do not necessarily reflect recent credit quality but rather banks’ expectations for the future.
As banks anticipate slowing economic growth, a rising unemployment rate, and potential interest rate cuts later in the year, Narron indicated these factors could lead to an increase in delinquencies and defaults by year-end.
Citi’s CFO Mark Mason pointed out that these concerns seem to predominantly affect lower-income consumers, who have seen their savings diminish post-pandemic. “While the overall U.S. consumer remains resilient, there is a noticeable divergence in performance based on income and credit scores,” he explained.
According to Mason, only the highest income quartile has managed to save more than they did in early 2019, with spending growth primarily coming from customers with a FICO score above 740. Conversely, those with lower credit scores are experiencing sharper declines in payment rates and are borrowing more due to the effects of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation rates to near its target of 2% before implementing anticipated rate cuts.
Despite banks’ preparations for increased defaults, Mulberry notes that current default rates do not indicate an imminent consumer crisis. He highlights the difference between homeowners and renters during the pandemic; while homeowners benefited from locking in low fixed rates, renters faced significant price hikes.
With rental costs rising over 30% nationwide since 2019 and grocery prices up 25%, renters who couldn’t secure low rates are experiencing significant financial strain.
Overall, the latest earnings reports reveal no new concerns regarding asset quality. Strong revenue, profits, and net interest income signal a robust banking sector. Mulberry concludes, “The banking system remains strong and sound, but we are closely monitoring the situation, as prolonged high-interest rates may lead to additional stress.”