With interest rates at their highest levels 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 increased their provisions for credit losses compared to the previous quarter. These provisions represent funds set aside to cover potential losses from credit risks, including bad debt and loans like commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America reserved $1.5 billion. Citigroup’s allowance for credit losses rose to $21.8 billion by the end of the quarter, more than tripling its reserves from the previous quarter. Wells Fargo set aside $1.24 billion.
These allocations indicate that banks are preparing for a potentially riskier lending environment, where both secured and unsecured loans might lead to larger losses. A recent New York Fed analysis reveals that U.S. households collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as consumers exhaust their pandemic-era savings and increasingly rely on credit. Total credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where the total surpassed a trillion dollars, according to data from TransUnion. The CRE sector remains particularly vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector’s situation is affected by the economic environment post-COVID, particularly due to the stimulus provided to consumers.
Looking ahead, the implications for banks might emerge in the coming months. Mark Narron, a senior director with Fitch Ratings, explained that current provisions may not accurately reflect recent credit quality but are based on banks’ expectations for the future.
In the short term, banks are anticipating slower economic growth, rising unemployment, and potential interest rate cuts in September and December. This could lead to more delinquencies and defaults as the year progresses.
Citi’s chief financial officer, Mark Mason, highlighted red flags among lower-income consumers who have seen their savings diminish since the pandemic. He commented on the divergent behaviors observed in consumer spending and payment rates, particularly noting that only the highest income quartile has managed to increase their savings since 2019.
The Federal Reserve has maintained interest rates at a 23-year peak of 5.25-5.5%, awaiting inflation indicators to stabilize towards its 2% target before considering rate cuts.
While banks prepare for potential spikes in defaults later this year, Mulberry mentioned that current default rates do not yet indicate a consumer crisis. He is particularly interested in the distinction between homeowners and renters during the pandemic. Homeowners, who secured low fixed rates, are less impacted, while renters face increased financial strain due to rising rental costs and stagnant wage growth.
Despite the challenges, the latest earnings reports reveal no significant issues with asset quality. According to Narron, strong revenues, profits, and net interest income are signs of a still-robust banking sector.
Mulberry emphasized the resilience of the financial system, stating that while potential stress from prolonged high interest rates exists, the banking sector remains solid and sound at present.