As interest rates reach levels not seen in over 20 years and inflation continues to pressure consumers, major banks are bracing for potential risks linked to their lending operations.
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-related risks, including bad debt and certain lending areas like commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America assigned $1.5 billion. Citigroup’s credit loss reserve reached $21.8 billion by the end of the quarter, representing a more than triple increase from the prior quarter. Wells Fargo set aside $1.24 billion for credit losses.
These increased reserves indicate the banks are preparing for a more difficult lending environment, where both secured and unsecured loans may lead to greater losses. A report from the New York Federal Reserve highlighted that Americans owe a total of $17.7 trillion in consumer, student, and mortgage loans.
Additionally, credit card use is surging, with rising delinquency rates as people deplete their savings gained during the pandemic and increasingly depend on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second straight quarter of exceeding the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also faces challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the ongoing impacts from the COVID-19 pandemic and the stimulus measures previously provided to consumers have shaped the current banking landscape.
However, experts suggest potential troubles may emerge for banks in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported in any quarter do not necessarily reflect credit quality for that specific period but rather what banks anticipate happening in the future.
Banks are forecasting slower economic growth, higher unemployment rates, and expected interest rate cuts later this year. This outlook could lead to increased delinquencies and defaults as the year ends.
Citi’s CFO, Mark Mason, pointed out that concerning trends seem more pronounced among lower-income consumers, who have seen their savings diminish since the pandemic. He observed a divide in consumer performance based on income levels, with only the highest income quartile maintaining higher savings than before 2019. Customers with a credit score above 740 are driving spending growth, while those with lower credit scores are facing significant challenges.
The Federal Reserve has maintained interest rates at a 23-year peak of 5.25-5.5%, awaiting inflation rates to stabilize before implementing anticipated cuts.
Despite preparing for increased defaults later this year, experts suggest current default rates do not indicate a broader consumer crisis. Mulberry highlighted the difference in circumstances for homeowners versus renters during the pandemic. Homeowners have locked in low fixed rates, minimizing their financial strain, while renters who missed the opportunity are now facing skyrocketing rents and increasing grocery costs.
Overall, the latest earnings reports indicate that there have been no significant changes in asset quality and report strong revenues and profits, signaling ongoing health in the banking sector. Mulberry expressed relief that the foundations of the financial system remain robust, though he cautioned that persistent high interest rates could lead to increased stress over time.