With interest rates at their highest in over 20 years and ongoing inflation impacting consumers, major banks are bracing for increased risks associated with their lending activities.
In the second quarter, financial giants such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo adjusted their provisions for credit losses upwards compared to the previous quarter. These provisions represent the amounts these institutions set aside to cover potential losses stemming from credit risks, including delinquent debts and commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America reserved $1.5 billion. Citigroup increased its allowance for credit losses to $21.8 billion by the end of the quarter, more than tripling its reserves from the prior quarter, and Wells Fargo’s provisions reached $1.24 billion.
The increase in reserves suggests that banks are preparing for a more challenging environment, where both secured and unsecured loans could lead to significant losses. A recent study by the New York Fed revealed that American households owe a total of $17.7 trillion across various consumer loans, student debt, and mortgages.
Additionally, both the issuance of credit cards and delinquency rates are on the rise as consumers deplete their pandemic-era savings and turn increasingly to credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where totals surpassed the trillion-dollar mark, according to TransUnion. Moreover, the commercial real estate sector remains in a vulnerable position.
Experts indicate that the economic impact of the pandemic and the subsequent stimulus actions have influenced consumer finances. Brian Mulberry, a client portfolio manager at Zacks Investment Management, highlighted the ongoing effects of COVID-19 on the banking sector and consumer health.
Looking ahead, issues for banks may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, stated that current provisions do not necessarily mirror credit quality from the past three months but are more indicative of banks’ predictions regarding future economic conditions.
Currently, banks anticipate a slowdown in economic growth, a potential rise in unemployment, and two likely interest rate cuts in September and December. This could lead to an increase in delinquencies and defaults as the year progresses.
Citigroup’s Chief Financial Officer Mark Mason pointed out that warning signs are particularly evident among lower-income consumers, whose savings have diminished since the pandemic. He noted the significant variance in financial behavior among different income groups, emphasizing that only those in the highest income quartile have maintained more savings since early 2019.
The Federal Reserve’s ongoing policy of keeping interest rates between 5.25% and 5.5% also plays a crucial role as it awaits evidence of stabilization in inflation towards its 2% target before considering rate cuts.
Despite the banks bracing for potential defaults in the latter part of the year, Mulberry noted that default rates have not yet escalated to a level indicative of an impending consumer crisis. He remarked on the differences between homeowners—who benefited from locking in low fixed mortgage rates—and renters, who face increasing rental costs.
From 2019 to 2023, rental prices surged over 30% while grocery costs climbed 25%, placing substantial pressure on renters who haven’t secured favorable financing conditions.
As for the recent earnings reports, Narron observed that there were no significant developments in asset quality this quarter. Strong revenues, profits, and resilient net interest income signal a largely healthy banking sector.
Murberry concluded that, while the current state of the banking system is robust and encouraging, it remains essential to monitor the long-term effects of sustained high-interest rates, which could introduce more pressure on financial institutions over time.