As interest rates reach their highest levels in over 20 years and inflation persists, 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 represent funds allocated by financial institutions to manage potential losses stemming from credit risks, which include delinquent debts and loans, particularly in commercial real estate.
JPMorgan allocated $3.05 billion for credit losses, while Bank of America set aside $1.5 billion. Citigroup’s allowance rose to $21.8 billion by the end of the quarter, more than tripling its reserves from the previous quarter. Wells Fargo’s provisions amounted to $1.24 billion. This buildup indicates that banks are preparing for a potentially riskier environment, given that both secured and unsecured loans may lead to greater losses for the largest banks in the country. A recent New York Fed analysis highlighted that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as consumers deplete their pandemic-era savings and increasingly rely on credit. According to TransUnion, credit card balances hit $1.02 trillion in the first quarter, marking the second consecutive quarter in which balances crossed the trillion-dollar threshold. Additionally, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the situation, noting the effects of past COVID-era stimulus on consumer health and banking conditions. However, he pointed out that while banks are anticipating challenges, current provisions may not accurately reflect recent credit quality but rather future expectations.
Mark Narron, a senior director at Fitch Ratings, explained that provisions now respond more to macroeconomic forecasts than to the immediate condition of loans. He indicated that banks are expecting slower economic growth, an increase in unemployment, and two expected interest rate cuts later this year, which could lead to higher delinquency and default rates.
Citi’s CFO, Mark Mason, observed that economic concerns appear primarily among lower-income consumers who have seen their savings diminish since the pandemic. He noted a disparity in financial behavior across income brackets, with only the highest-income quartile reporting increased savings since early 2019.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, waiting for inflation to stabilize toward its 2% target before considering any rate cuts.
Despite banks preparing for potential defaults, current rates do not yet indicate a consumer crisis, according to Mulberry. He noted the contrast between homeowners who secured low fixed-rate mortgages during the pandemic and renters, who are now facing increased financial pressure due to rising rental prices and inflation.
Overall, recent earnings reports indicate nothing particularly alarming regarding asset quality in the banking sector. Analysts highlighted strong revenues, profits, and steady net interest income as signs of resilience. Mulberry emphasized a crucial point: while the banking sector remains relatively strong and sound, prolonged high interest rates could lead to increasing stress in the future.