As interest rates reach their highest levels in over 20 years and inflation continues to pressure consumers, major banks are bracing for potential risks associated with 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 by banks to cover anticipated losses from credit risks, including defaults and problematic debts, particularly in commercial real estate loans.
JPMorgan allocated $3.05 billion for credit loss provisions in this quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses surged to $21.8 billion at the end of the quarter, more than tripling from the previous period. Wells Fargo’s provisions stood at $1.24 billion.
The increase in provisions indicates that banks are preparing for a riskier financial landscape where both secured and unsecured loans could lead to greater losses. A recent report from the New York Federal Reserve found that Americans currently owe a total of $17.7 trillion in consumer loans, mortgages, and student debt.
With credit card balances rising, delinquency rates are following suit as many individuals exhaust their pandemic-era savings and turn to credit cards. In the first quarter of the year, credit card balances hit $1.02 trillion, marking the second consecutive quarter in which balances surpassed this threshold. The commercial real estate sector remains particularly vulnerable as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, pointed out that the current economic environment, compounded by prior stimulus measures, continues to shape consumer banking behaviors.
Experts caution that the banks’ provisions reflect anticipated future risks rather than present credit quality. According to Mark Narron from Fitch Ratings, “The provisions that you see at any given quarter don’t necessarily reflect credit quality for the last three months, they reflect what banks expect to happen in the future.”
Looking ahead, banks are forecasting slower economic growth and increased unemployment, alongside expected interest rate cuts later this year. This could lead to a rise in delinquencies and defaults as the year progresses.
Citigroup’s Chief Financial Officer Mark Mason highlighted that the risk factors appear to be concentrated among lower-income consumers, whose savings have been depleted since the pandemic. While the overall U.S. consumer remains resilient, performance varies significantly by income level.
Only the top income quartile has more savings now than they did in early 2019, with higher-FICO score consumers driving spending growth and maintaining prompt payment rates. Conversely, lower-FICO customers are experiencing a decline in payment rates and are increasingly affected by rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting signs of inflation stabilizing towards its 2% target before implementing anticipated rate cuts.
Despite these preparations for a potential rise in defaults later in the year, experts like Mulberry indicate that current default rates do not signify an impending consumer crisis. He suggests observing the differences between homeowners and renters during this time, noting that while homeowners benefitted from locking in low fixed rates, renters are feeling the pressure from soaring rental prices and stagnant wage growth.
For now, the overall health of the banking sector appears stable, with strong revenues, profits, and net interest income as positive signals. As Narron stated, this quarter did not reveal any new asset quality issues. However, analysts are closely monitoring the situation, acknowledging that persistent high interest rates could lead to increased stress within the financial system.