With interest rates at their highest levels in over two decades and ongoing inflation pressures on consumers, major banks are bracing for increased risks in their lending operations.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses from the previous quarter. These reserves are set aside by banks to offset potential losses from credit risks, including defaults on loans and bad debt related to areas such as commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, a significant increase from the previous quarter, and Wells Fargo reported provisions of $1.24 billion.
These increased provisions indicate that banks are preparing for a challenging lending environment, where both secured and unsecured loans could lead to larger losses for some of the country’s largest financial institutions. Recent analysis from the New York Fed highlighted that Americans collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
As pandemic-era savings dwindle, credit card use and delinquency rates are climbing. In the first quarter, credit card balances reached $1.02 trillion, marking the second consecutive quarter that total balances exceeded a trillion dollars, according to TransUnion. The commercial real estate sector also remains in a precarious state.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, pointed out that the impact of the pandemic and subsequent government stimulus has altered the banking landscape and consumer financial health.
Experts note that the provisions reported by banks do not merely reflect recent credit quality but are predictive of future trends. Mark Narron from Fitch Ratings explained that the shift in forecasting has moved from reacting to default rates to proactively adjusting provisions based on macroeconomic expectations.
Looking ahead, banks are anticipating slower economic growth, an increased unemployment rate, and potential interest rate cuts later this year, which may lead to a rise in delinquencies and defaults.
Citi’s CFO, Mark Mason, highlighted that concerns are mounting, particularly among lower-income consumers, whose savings have significantly decreased since the pandemic. He noted that while the overall U.S. consumer remains resilient, financial behavior varies widely across income levels and credit scores.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation towards the central bank’s target before any rate cuts are implemented.
Despite banks preparing for potential defaults, Mulberry stated that current default rates do not yet suggest a consumer crisis. He emphasized the difference in financial burdens faced by homeowners compared to renters, with many homeowners benefiting from historically low fixed mortgage rates while renters struggle with rising costs.
Overall, analysts found no major changes in asset quality in the latest earnings reports, indicating that the banking sector remains healthy with strong revenues and net interest income. Mulberry expressed cautious optimism, recognizing the resilience of the financial system but warning that prolonged elevated interest rates could lead to increased stress.