With interest rates reaching their highest in over 20 years and inflation continuing to pressure consumers, major banks are bracing for increased risks associated with their lending practices.
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 funds that banks allocate to cover potential losses from credit risks, such as bad debt and delinquent loans, including those related to commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance totaled $21.8 billion at the quarter’s end, significantly more than its previous credit reserve, and Wells Fargo had provisions amounting to $1.24 billion.
These increased reserves reflect banks’ concerns about a more precarious lending environment, where both secured and unsecured loans may lead to greater losses for the nation’s largest financial institutions. According to a recent analysis by the New York Fed, Americans currently owe a staggering $17.7 trillion across various consumer debts, including student loans and mortgages.
Rising credit card issuance and delinquency rates are evident as individuals deplete their pandemic-era savings and increasingly turn to credit. As reported by TransUnion, credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances exceeded the trillion-dollar threshold. The commercial real estate sector also remains in a vulnerable position.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, highlighted the ongoing impact of the COVID-19 pandemic on the banking sector and consumer health, attributing part of the stability to the government stimulus provided during the crisis.
Looking forward, banks are expecting challenges in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that quarterly provisions do not solely reflect consumers’ recent credit quality but rather what banks foresee for the future.
Currently, banks anticipate slowing economic growth, a rising unemployment rate, and two expected interest rate cuts later this year, which could lead to increased delinquencies and defaults by year-end.
Citi’s chief financial officer, Mark Mason, pointed out that the concerning trends are particularly pronounced among lower-income consumers who have seen their savings diminish since the pandemic.
“While we continue to see an overall resilient U.S. consumer, we also continue to see a divergence in performance and behavior across FICO and income bands,” Mason stated. He noted that only the highest income quartile has seen an increase in savings since early 2019, with high credit-worthy customers maintaining strong spending and payment rates, while those with lower credit scores experience more significant declines in their payment rates amid rising inflation and interest rates.
The Federal Reserve has maintained interest rates between 5.25% and 5.5%, a 23-year high, as it awaits inflation measures to align with its 2% target before implementing anticipated rate cuts.
Despite banks preparing for a potential rise in defaults later this year, current rates of default do not yet signal a consumer crisis, according to Mulberry. He emphasized the difference in experiences between homeowners and renters during the pandemic, noting that homeowners have benefitted from locking in low fixed rates on their debt.
In contrast, renters, who have faced over a 30% rise in rent nationwide since 2019 and a 25% increase in grocery costs, have seen their budgets strained due to rental prices that have outpaced wage growth.
For now, the latest earnings reports indicate that there are no significant new concerns regarding asset quality. Strong revenues, profits, and net interest income suggest that the banking sector remains robust.
Mulberry remarked, “There’s some strength in the banking sector that I don’t know was totally unexpected, but I think it’s certainly a relief to say that the structures of the financial system are still very strong and sound at this point in time.” However, the persistence of high interest rates could exacerbate stress within the sector.