With interest rates at their highest level in over two decades and inflation impacting consumers, major banks are bracing themselves for potential risks associated with their lending activities.
In the second quarter, prominent banks such as 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 financial institutions to cover possible losses from credit risks, including delinquent debts and various lending practices such as commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses, Bank of America allocated $1.5 billion, Citigroup’s provision amounted to $21.8 billion at the end of the quarter, marking a significant increase from the previous period, while Wells Fargo designated $1.24 billion for the same purpose.
These reserve increases indicate that banks are preparing for a more challenging economic landscape where both secured and unsecured loans may lead to greater losses. According to a recent report by the New York Federal Reserve, American households currently hold a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are climbing as individuals begin to exhaust their pandemic-era savings and increasingly depend on credit. Credit card balances crossed the $1 trillion threshold for the second consecutive quarter, as reported by TransUnion. The commercial real estate sector continues to face uncertainties as well.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the aftermath of the COVID pandemic still affects banking and consumer health, largely due to the stimulus measures applied during that time.
However, challenges for banks are expected to manifest over the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, explained that the provisions reported in any quarter do not solely reflect past credit quality, but instead are indicative of future expectations.
He noted a shift from a system where rising loan defaults increase provisions to one where macroeconomic outlooks heavily influence provisioning practices. Banks are currently forecasting slower economic growth, a higher unemployment rate, and anticipate two interest rate cuts later this year.
Citi CFO Mark Mason highlighted that signs of strain are notably concentrated among lower-income consumers, many of whom have seen their savings diminish post-pandemic. He pointed out that only the highest income quartile has maintained or increased their savings since early 2019, with consumers holding high FICO scores driving spending growth.
The Federal Reserve currently maintains interest rates at a 23-year peak of 5.25-5.5%, monitoring inflation trends before executing the anticipated rate cuts.
Despite banks preparing for a potential rise in defaults later this year, the current data does not indicate an immediate consumer crisis. Mulberry noted the contrast between homeowners, who secured low fixed rates during the pandemic, and renters, who are now facing significant inflationary pressures. Rent prices have surged over 30% nationally since 2019, while grocery costs have risen by 25%.
For now, the latest earnings reports reveal no alarming changes in asset quality, as robust revenues, profits, and strong net interest income suggest ongoing stability in the banking sector. Mulberry expressed relief over the resilience of the financial system, despite acknowledging that persistent high interest rates could introduce more stress in the future.