Amid rising interest rates, which are currently at their highest in over 20 years, and persistent inflation affecting consumers, major banks are bracing for increased risks associated with their lending operations.
In the second quarter, prominent banks 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 are funds allocated by financial institutions to safeguard against potential losses stemming from credit risk, which includes defaulted loans and risky lending practices, particularly in commercial real estate.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses rose to $21.8 billion at the end of the quarter, more than tripling the amount from the previous period. Wells Fargo’s provisions totaled $1.24 billion.
These increased reserves highlight banks’ preparation for a more challenging financial landscape, where both secured and unsecured loans could lead to more significant losses. A recent study by the New York Federal Reserve revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, as savings from the pandemic era diminish, the issuance of credit cards and delinquency rates are climbing. Credit card balances reached $1.02 trillion in the first quarter this year, marking the second consecutive quarter that total balances surpassed the trillion-dollar threshold, according to TransUnion. Meanwhile, the commercial real estate sector remains in a sensitive state.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking environment is still adjusting from the impacts of COVID-19, primarily influenced by government stimulus measures directed at consumers.
Looking forward, the challenges for banks are anticipated to intensify in the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, emphasized that the provisions seen in any given quarter do not necessarily reflect recent credit quality but rather what banks predict will happen in the near future.
Currently, banks expect to see slowed economic growth, a rise in unemployment, and potential interest rate cuts later this year in September and December. These factors may lead to increased delinquencies and defaults as the year progresses.
Citi’s Chief Financial Officer Mark Mason pointed out concerning trends among lower-income consumers, who have seen their savings decline since the pandemic. He stated that while the overall U.S. consumer remains resilient, performance varies significantly based on income and credit scores.
Mason noted that only the top income quartile has maintained higher savings since 2019, while customers with credit scores over 740 are contributing to spending growth and high payment rates. In contrast, those with lower credit scores are facing declining payment rates and are borrowing more, heavily impacted by rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year peak of 5.25-5.5%, awaiting inflation indicators to stabilize around their 2% target before implementing expected rate cuts.
Despite banks preparing for higher default rates later in the year, Mulberry comments that current default rates do not indicate an impending consumer crisis. He is noting distinctions between homeowners who benefited from low fixed rates during the pandemic and renters facing increased financial strain.
Mulberry highlighted that while interest rates have risen significantly, homeowners locked in favorable rates on their mortgage debt, insulating them from immediate economic pressure. Renters, however, have been struggling with nationwide rent surges of over 30% since 2019 and grocery price increases of 25% during the same timeframe, creating financial stress.
Overall, the latest earnings reports show that the banking sector still exhibits solid fundamentals, as asset quality remains stable. Narron remarked that strong revenues, profits, and net interest income point to a healthy banking environment.
Mulberry summarized that there is reassuring strength within the financial system, but cautioned that prolonged high interest rates could introduce more pressure over time.