As interest rates soar to their highest levels in over two decades and inflation continues to pressure consumers, major banks are preparing for heightened risks linked to 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 are funds set aside to mitigate potential losses from credit risks, such as defaults and bad debts, including commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses during the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, representing a more than threefold increase from the prior quarter, and Wells Fargo established provisions of $1.24 billion.
These reserve increases indicate that banks are bracing for a riskier lending environment, as both secured and unsecured loans could result in larger losses for some of the largest financial institutions in the country. A recent analysis by the New York Federal Reserve revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Furthermore, credit card issuance is on the rise, with delinquency rates climbing as consumers deplete their savings accumulated during the pandemic and turn increasingly to credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where the total surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector remains vulnerable as well.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking sector is still emerging from the effects of the COVID-19 pandemic, particularly concerning consumers’ financial health, which benefited from government stimulus efforts.
Issues for banks are anticipated to arise in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that quarterly provisions do not necessarily reflect a bank’s recent credit quality but rather their expectations for the future.
Narron noted that banks are forecasting slowing economic growth, increased unemployment rates, and two anticipated interest rate cuts later this year in September and December, which could lead to higher delinquencies and defaults toward the end of the year.
Citigroup’s Chief Financial Officer Mark Mason highlighted that the risks are particularly pronounced among lower-income consumers, who have experienced a decline in savings since the pandemic.
While there remains an overall resilient U.S. consumer base, Mason emphasized the disparities in financial performance across different income and credit score brackets. He pointed out that only the highest income quartile has managed to increase their savings since early 2019, and those with strong credit scores are driving spending and maintaining high repayment rates. In contrast, lower-scoring consumers are facing greater payment declines and are borrowing more as they are more significantly affected by rising inflation and interest rates.
The Federal Reserve continues to hold interest rates at a 23-year high of 5.25-5.5% while awaiting inflation metrics to stabilize towards its 2% target before implementing the anticipated rate cuts.
Despite preparations for potential increases in defaults later this year, Mulberry notes that defaults have not yet increased to a level indicative of a consumer crisis. He is observing trends between homeowners and renters from the pandemic period.
Though interest rates have risen dramatically, homeowners who secured low fixed-rate mortgages are largely insulated from current financial pressures, while renters have faced surging rental costs that have outpaced wage growth.
Currently, analysts suggest that the banking sector is displaying stability, as the latest earnings reports indicated no significant changes in asset quality. Promising revenues, profits, and resilient net interest income suggest a healthy banking environment overall.
Mulberry remarked on the strength of the financial system, stating that while the situation is stable now, prolonged high-interest rates could lead to increased financial stress.