As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are preparing for heightened risks linked to their lending practices. In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside by financial institutions to cover potential losses stemming from credit risks, including delinquent loans and commercial real estate debt.
JPMorgan allocated $3.05 billion for credit loss provisions, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses climbed to $21.8 billion, marking a tripling from the previous quarter, and Wells Fargo’s provisions reached $1.24 billion. These adjustments indicate that banks are bracing for a challenging environment, where both secured and unsecured loans may lead to larger losses.
The New York Federal Reserve recently revealed that American households collectively owe $17.7 trillion in consumer loans, student debt, and mortgages. Additionally, credit card use and delinquency rates are climbing as pandemic savings diminish and consumers increasingly rely on credit. TransUnion reported that credit card balances hit $1.02 trillion in the first quarter, continuing a trend of surpassing the trillion-dollar mark for the second consecutive quarter. Commercial real estate also remains under pressure.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked that the banking system is still recovering from the impact of COVID-19, largely influenced by consumer stimulus measures. However, potential issues for banks are anticipated in the coming months.
Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, clarified that current provisions do not directly reflect credit quality from the recent past but rather indicate banks’ expectations for the future. He explained that there has been a shift in how banks manage provisions, now driven predominantly by macroeconomic forecasts.
Short-term projections from banks suggest slowing economic growth, increasing unemployment, and potential interest rate cuts later in the year, which could lead to more delinquencies and defaults.
Citi’s CFO, Mark Mason, noted that concerning trends are evident among lower-income consumers, who have seen their savings diminish since the pandemic. While the overall U.S. consumer appears resilient, there are diversities in spending behaviors across income levels. Mason highlighted that only the highest income quartile has maintained or increased their savings since 2019, while those with lower credit scores are facing payment drops and relying more on credit due to inflation and high interest rates.
The Federal Reserve has maintained a 23-year high interest rate of 5.25-5.5%, waiting for inflation to stabilize towards its 2% target before considering rate cuts.
Despite banks’ preparations for potential defaults, the current rate of defaults does not indicate an impending consumer crisis, according to Mulberry. He drew attention to the difference between homeowners and renters during the pandemic, noting that homeowners benefited from locking in low interest rates, while renters, facing increased rental prices and rising living costs, are experiencing greater financial stress.
Overall, the latest earnings reports signaled that the banking sector remains fundamentally sound, with strong revenues and net interest income. Observers note that while certain stresses are present, the financial system is still resilient, but should be monitored closely as high interest rates persist.