As interest rates reach their highest levels in over 20 years and inflation continues to weigh heavily on consumers, major banks are bracing for increased risks associated with their lending operations.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their provisions for credit losses, indicating a cautious outlook. These provisions represent funds set aside to cover potential losses linked to credit risks, including bad debt and loan defaults, particularly in commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America contributed $1.5 billion. Citigroup’s allowance for credit losses soared to $21.8 billion at the end of the quarter—more than tripling its reserves from the previous quarter. Wells Fargo set aside $1.24 billion for potential losses.
These increased provisions reflect the banks’ preparations for a more challenging economic environment, where both secured and unsecured loans pose a higher risk of generating losses. A recent analysis by the New York Fed revealed that American households now carry a total of $17.7 trillion in debt related to consumer loans, student loans, and mortgages.
The trend in credit card issuance and delinquency rates also indicates rising financial pressure on consumers, as savings from the pandemic era are dwindling. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total balances exceeded the trillion-dollar threshold, according to TransUnion. Additionally, the commercial real estate sector remains vulnerable.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted that challenges in banking and consumer health are linked to the impact of pandemic-related stimulus measures. However, banks are anticipating difficulties ahead.
Mark Narron, a senior director at Fitch Ratings, pointed out that current provisions reflect expectations of future credit quality rather than past performance. He highlighted a shift from using loan performance as a basis for provisioning to relying on macroeconomic forecasts.
Looking ahead, banks are predicting slowed economic growth, rising unemployment, and potential interest rate cuts in September and December. This outlook could lead to increased delinquencies and defaults as the year closes.
Citigroup’s CFO Mark Mason observed that potential risks appear to be concentrated among lower-income consumers, many of whom have depleted their savings since the pandemic. He noted a disparity in consumer behavior, with only the highest income quartile having more savings than in early 2019. Consumers with high credit scores are driving spend growth and maintaining high payment rates, while those with lower scores are struggling.
The Federal Reserve has maintained interest rates at a range of 5.25-5.5% as it monitors inflation’s movement towards its 2% target before considering rate cuts.
Despite banks preparing for higher default rates, current trends do not indicate an impending consumer crisis. Mulberry is observing the differences between homeowners and renters during this period. Homeowners, who locked in low fixed rates, are less affected by rising costs, unlike renters who face escalating rent and grocery prices.
Ultimately, the latest earnings indicate no significant changes in asset quality. Industry experts note that strong revenues and net interest income suggest the banking sector remains robust. Mulberry emphasized that, while the banking system appears sound, the ongoing high-interest rate environment could increase stress over time.