With interest rates reaching their highest levels in over two decades and inflation continuing to impact consumers, major banks are preparing 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 are funds set aside by financial institutions to mitigate potential losses from credit risk, including bad debts and lending practices such as commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup exceeded expectations with an allowance for credit losses of $21.8 billion by the end of the quarter, significantly tripling its reserves from the previous quarter. Wells Fargo also established provisions amounting to $1.24 billion.
This increase in reserves signals that banks are bracing for a challenging financial environment where both secured and unsecured loans may lead to greater losses. A recent analysis of household debt by the New York Federal Reserve revealed that Americans currently owe a total of $17.7 trillion in consumer, student, and mortgage loans.
Additionally, credit card issuances and delinquency rates are rising as individuals deplete their savings accumulated during the pandemic and increasingly depend on credit. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where total balances surpassed that trillion-dollar threshold. Commercial real estate also remains in a vulnerable position.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking sector’s health is still influenced by the stimulus measures implemented during the COVID-19 pandemic.
However, banks may encounter more significant problems in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that current provisions do not necessarily indicate the quality of credit over the last few months but instead reflect banks’ expectations for the future.
Narron indicated that banks anticipate slowing economic growth, a rise in unemployment, and two interest rate cuts in September and December this year, which may lead to more delinquencies and defaults as the year closes.
Citigroup’s chief financial officer, Mark Mason, observed that warning signs are particularly evident among lower-income consumers, who have seen their savings diminish in the years following the pandemic. He explained that while the overall U.S. consumer remains resilient, there are significant performance disparities among different income levels and credit scores.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25%-5.5% while monitoring inflation toward its target of 2% before proceeding with anticipated rate cuts.
As banks brace for potential defaults in the latter part of the year, Mulberry noted that current default rates do not yet indicate a consumer crisis. He emphasized the distinction between homeowners who locked in low fixed rates during the pandemic and renters who face higher costs.
Despite rising rates, many homeowners are not feeling financial pressure due to their low mortgage rates, while renters, who did not benefit from the same opportunities, are feeling the strain from rising rents—up over 30% nationwide since 2019—and significant increases in grocery costs.
Currently, the general outlook from the latest earnings reports reveals no new concerns regarding asset quality. Banks have reported strong revenues, profits, and resilient net interest income, indicating a still-stable banking sector.
Mulberry noted the existing strength in the banking sector, emphasizing the importance of closely monitoring the situation as prolonged high-interest rates could lead to increased stress in the future.