With interest rates at their highest in over two decades and inflation continuing to affect consumers, major banks are bracing for increased 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 set aside by financial institutions to offset potential losses from lending risks, including bad debt.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, marking over a threefold increase in its credit reserves from the previous quarter. Wells Fargo reported provisions of $1.24 billion.
The buildup of reserves indicates that banks are preparing for a riskier economic climate, as both secured and unsecured lending may result in significant losses. The New York Fed’s recent analysis revealed that Americans collectively owe $17.7 trillion in consumer and student loans, as well as mortgages.
Credit card issuance and delinquency rates are also climbing as consumers deplete their pandemic-related savings and increasingly rely on credit. In the first quarter, total credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. Commercial real estate loans remain in a precarious situation as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, stated, “We’re still coming out of this COVID era,” emphasizing the impact of consumer stimulus during this time.
Experts caution that any potential problems for banks may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that the provisions reported in any given quarter reflect banks’ expectations for future credit quality rather than past performance.
As banks anticipate a slowing economy and higher unemployment rates, along with expected interest rate cuts this September and December, there may be an increase in delinquencies and defaults by year-end.
Citigroup’s CFO Mark Mason pointed out that concerns are particularly evident among lower-income consumers, who have seen their savings decrease since the pandemic.
“While we continue to see an overall resilient U.S. consumer, we also continue to see a divergence in performance and behavior across income bands,” Mason commented during a recent analyst call. He noted that only the highest income quartile has managed to maintain savings since 2019, while lower income groups are facing greater financial distress due to rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25% to 5.5%, pending stabilization of inflation toward the central bank’s 2% target.
Despite banks preparing for increased defaults later this year, Mulberry emphasized that current default rates do not signal an impending consumer crisis. He indicated that a key difference lies between homeowners and renters, noting that homeowners, who locked in low fixed rates, are not experiencing the same level of financial strain as renters facing significant rental increases.
Since 2019, rents have surged more than 30%, and grocery prices have risen 25%, disproportionately affecting renters who have not benefited from low mortgage rates.
In summary, the latest earnings reports revealed that the banking sector remains robust, with strong revenues, profits, and net interest income suggesting ongoing stability. “There’s some strength in the banking sector that I don’t know was totally unexpected… the structures of the financial system are still sound at this point in time,” Mulberry concluded. Nonetheless, vigilance is necessary as prolonged high interest rates can increase stress within the financial system.