As interest rates reach their highest levels in over two decades and inflation pressures consumers, major banks are preparing for increased risks associated with their lending practices.
In the second quarter of the year, major banks, including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo, increased their provisions for credit losses compared to the prior quarter. These provisions represent funds set aside to cover potential losses from credit risks, including bad debt and lending, particularly in commercial real estate.
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 hit $21.8 billion by the end of the quarter, marking a tripling of its reserve compared to the previous quarter. Wells Fargo also recorded provisions of $1.24 billion.
These increased provisions indicate that banks are bracing for a riskier environment, where both secured and unsecured loans may result in greater losses. A study from the New York Federal Reserve revealed that Americans are currently burdened with $17.7 trillion in consumer debt, including credit balances, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as consumers deplete their savings from the pandemic and rely more heavily on borrowing. In the first quarter of this year, credit card balances reached $1.02 trillion, reflecting a significant upward trend for the second consecutive quarter, according to data from TransUnion. The commercial real estate sector also remains vulnerable.
Experts note that the banking industry is emerging from the pandemic while contending with the effects of previous consumer stimulus.
However, any significant challenges for the banks are anticipated in the upcoming months. “The provisions at any quarter do not necessarily reflect credit quality for the most recent three months but rather what banks expect will occur in the future,” explained Mark Narron from Fitch Ratings’ Financial Institutions Group.
He further stated that banks are currently projecting slower economic growth, an increase in unemployment, and potential interest rate cuts later in the year, which may lead to higher delinquency and default rates as the year concludes.
Citigroup’s CFO, Mark Mason, emphasized that the red flags are predominantly concerning lower-income consumers who have depleted their savings since the pandemic. “While the overall U.S. consumer remains resilient, there are noticeable differences in performance based on income and credit score,” Mason said. He pointed out that only the highest income quartile has increased savings compared to 2019, whereas consumers with lower credit scores are experiencing declines in payment rates and increased borrowing, influenced by high inflation and interest rates.
The Federal Reserve maintains interest rates at a high range of 5.25-5.5%, awaiting signs of inflation stabilization toward its 2% target before implementing anticipated rate cuts.
Despite banks bracing for more defaults later in the year, current default rates do not indicate a consumer crisis, according to Mulberry. He is particularly focused on the differences between homeowners and renters during the pandemic. Homeowners, who secured low fixed rates on their debts, are less affected by rising rates, whereas renters face escalating costs due to surging rental prices.
From the latest earnings reports, there is no stark change in asset quality, indicating that the banking sector remains robust, with strong revenues and profits continuing to support net interest income.
Overall, the resilience of the banking sector is encouraging, yet the persistence of high interest rates continues to present challenges.