Major banks are bracing for increased risks in their lending practices as interest rates reach the highest levels in over 20 years and inflation continues to pressure consumers. 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 represent funds set aside by financial institutions to cover potential losses from credit risks, including delinquent loans such as commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, more than tripling its reserves from the previous quarter. Wells Fargo reserved $1.24 billion for potential losses. These increases indicate that banks are preparing for a more challenging economic landscape, where both secured and unsecured loans may lead to greater losses.
A recent analysis from the New York Federal Reserve revealed that Americans currently owe a collective $17.7 trillion in consumer loans, student loans, and mortgages. Additionally, rising credit card issuance and delinquency rates are becoming apparent as individuals deplete their pandemic-era savings and increasingly rely on credit. Total credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter in which the total exceeded the trillion-dollar threshold, according to TransUnion. The commercial real estate sector remains particularly vulnerable as well.
Experts suggest that while banks are currently solid, potential issues could arise in the coming months. Mark Narron from Fitch Ratings noted that current provisions are more indicative of banks’ future expectations rather than reflecting recent credit quality. He explained that there has been a shift from a reactive approach to provisioning that responds to deteriorating loans to one more influenced by macroeconomic forecasts.
In the short term, banks are predicting a slowdown in economic growth, an increase in unemployment rates, and two anticipated interest rate cuts in September and December. These conditions may result in more delinquencies and defaults as the year progresses.
Citi’s CFO, Mark Mason, pointed to concerning trends among lower-income consumers, who have seen their savings diminish since the pandemic. He remarked that the highest-income quartile is the only group that has managed to accumulate more savings since 2019, while individuals with lower credit scores are experiencing increased borrowing and declining payment rates due to the impacts of high inflation and interest rates.
The Federal Reserve continues to maintain its interest rates between 5.25% and 5.5%, the highest levels in 23 years, while waiting for inflation to stabilize near its 2% target before implementing expected rate cuts.
Despite the preparations for increased defaults in the latter part of the year, the current rates of defaults are not indicative of an impending consumer crisis, according to Mulberry from Zacks Investment Management. He pointed out that the dynamics differ between homeowners and renters. Homeowners have benefitted from locking in low fixed rates during the pandemic, insulating them somewhat from rising rates, while renters face substantial budget strains due to skyrocketing rents, which have soared more than 30% since 2019 alongside a 25% increase in grocery costs.
The recent earnings reports indicate that the banking sector remains healthy, with strong revenues and profits, demonstrating resilience in net interest income. Observers note that while there’s strength within the financial system, sustained high interest rates could eventually lead to greater stress for both banks and consumers.