As interest rates reach their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for increased risks linked to their lending operations.
In the second quarter, major financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo have all increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks reserve to cover potential losses arising from credit risks, including unpaid debts and loans, particularly in commercial real estate.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America reserved $1.5 billion. Citigroup’s allowance for credit losses unexpectedly rose to $21.8 billion by the end of the quarter, more than tripling its previous quarter’s reserves. Meanwhile, Wells Fargo allocated $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging lending environment, with risks potentially leading to greater losses on both secured and unsecured loans. The New York Federal Reserve recently analyzed household debt, revealing that Americans collectively owe $17.7 trillion across various consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are on the rise as consumers exhaust their savings accumulated during the pandemic. Current credit card balances have reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total balances surpassed the trillion-dollar milestone. Commercial real estate also remains in a precarious situation.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the lingering impacts of the COVID era are still being felt, particularly concerning consumer health and banking, largely driven by prior stimulus efforts.
However, challenges for banks are anticipated in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that the provisions set aside by banks do not necessarily reflect actual credit quality over the past three months; rather, they take into account future expectations.
Narron added that the economic outlook is concerning, with projections indicating slow economic growth, rising unemployment, and potential interest rate cuts later this year. This situation could lead to higher rates of delinquency and default by the year’s end.
Citi’s CFO, Mark Mason, highlighted that these troubling trends are particularly prevalent among lower-income consumers, who have seen their savings deplete since the pandemic began. While the U.S. consumer remains resilient overall, performance and behavior vary significantly across different income levels and credit scores. Only the top income quartile has managed to save more than they did at the beginning of 2019, while those with lower credit scores are experiencing a rise in borrowing and a drop in payment rates due to high inflation and interest rates.
The Federal Reserve continues to maintain interest rates at a 23-year high of 5.25-5.5%, awaiting inflation to stabilize near the central bank’s target of 2% before considering cuts.
Despite banks anticipating an uptick in defaults later in the year, current statistics do not indicate a significant consumer crisis. Mulberry emphasizes the difference between homeowners and renters during the pandemic. Although interest rates have climbed significantly, homeowners secured low fixed-rate mortgages, sparing them from financial strain. In contrast, renters, facing rising costs—over 30% increase in national rents and 25% increase in grocery prices since 2019—are experiencing heightened stress in managing monthly expenses.
Overall, the recent earnings reports suggest that there are no significant new concerns regarding asset quality in the banks. Strong revenues and profits combined with healthy net interest income point to a robust banking sector for now. Mulberry concluded that although some strength persists within the financial system, sustained high-interest rates could lead to increasing stress moving forward.