As interest rates remain at their highest levels in over 20 years and inflation continues to impact consumers, major banks are bracing for increased risks associated with their lending activities.
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 are funds that banks allocate to cover potential losses due to credit risk, which includes delinquent loans and commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s credit loss allowance reached $21.8 billion at the close of the quarter, more than tripling its reserve build from the previous quarter. Wells Fargo earmarked $1.24 billion for this purpose.
These increased provisions indicate that banks are preparing for a more challenging lending environment, one that could see higher losses on both secured and unsecured loans. According to the New York Federal Reserve, Americans currently owe a total of $17.7 trillion in consumer debts, student loans, and mortgages.
Credit card issuance and delinquency rates are also climbing as consumers exhaust their savings from the pandemic and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances exceeded a trillion dollars, according to TransUnion.
“We’re still emerging from the COVID era, particularly concerning banking and consumer health, heavily influenced by the stimulus provided to consumers,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Future challenges for banks are expected as concerns grow. “The provisions reported each quarter do not necessarily reflect the credit quality of loans issued in the last three months but rather the banks’ expectations of what may occur down the line,” explained Mark Narron, a senior director at Fitch Ratings.
Banks anticipate slower economic growth, rising unemployment, and potential interest rate cuts later this year, which may lead to increased delinquencies and defaults as the year comes to a close.
Citi’s chief financial officer, Mark Mason, pointed out that the signs of stress are particularly evident among lower-income consumers, who have seen their savings decline since the pandemic began. “While the overall U.S. consumer remains resilient, performance varies notably across different income levels,” he remarked.
He added that only consumers in the highest income bracket have managed to increase their savings since early 2019, and those with credit scores above 740 are driving spending growth and maintaining high payment rates. Conversely, consumers with lower credit scores are experiencing a decline in payment rates and borrowing more due to the impacts of inflation and rising interest rates.
The Federal Reserve has held interest rates steady at a 23-year high of 5.25-5.5%, awaiting a stabilization of inflation towards its 2% target before considering the anticipated rate cuts.
Despite the banks preparing for potential defaults in the latter half of the year, there has not yet been a significant rise in default rates indicating a consumer crisis, according to Mulberry. He is particularly monitoring the differences in financial stress between homeowners and renters.
“There’s a significant divide; while interest rates have risen, homeowners have locked in low fixed rates, so they aren’t feeling as much strain,” Mulberry noted. “In contrast, renters, who missed that opportunity, are significantly affected by rising rents, which have increased over 30% nationwide since 2019.”
Currently, the key insight from the latest earnings reports is that “there were no new issues regarding asset quality this quarter,” according to Narron. The banking sector has shown strong revenues, profits, and a resilient net interest income, indicating ongoing health in the industry.
“While some strength in the banking sector may not have been entirely unexpected, it does provide reassurance that the foundations of the financial system remain sound at this time,” Mulberry stated. “However, the longer interest rates remain this high, the more tension it creates.”