As interest rates reach their highest levels in over 20 years and inflation continues to impact consumers, major banks are preparing for potential risks associated with their lending activities.
In the second quarter, major banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks set aside to cover expected losses from credit risks, including delinquent or bad debts and lending, such as commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup increased its allowance for credit losses to $21.8 billion by the end of the quarter, more than tripling its reserves from the previous quarter. Wells Fargo noted provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a challenging economic environment, where both secured and unsecured loans could result in higher losses for some of the country’s leading banks. A recent analysis from the New York Fed revealed that Americans collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Furthermore, credit card issuance is rising, along with delinquency rates, as consumers begin to rely more on credit due to dwindling pandemic-era savings. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter that the total has surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also remains vulnerable.
Experts note that the effects of the COVID-19 pandemic are still being felt, particularly regarding banking and consumers’ financial health, which had been supported by government stimulus measures.
However, challenges for banks are likely to emerge in the coming months. “The provisions that you see at any given quarter don’t necessarily reflect credit quality for the last three months; they reflect what banks expect to happen in the future,” explained Mark Narron, a senior director at Fitch Ratings.
Banks are currently projecting slowing economic growth, an increase in unemployment rates, and anticipate interest rate cuts later this year, which could contribute to more delinquencies and defaults by year’s end.
Citi’s CFO Mark Mason pointed out that warning signs are primarily affecting lower-income consumers, who have seen their savings decline post-pandemic. “While we continue to see an overall resilient U.S. consumer, we observe a divergence in performance and behavior across income levels,” Mason stated. He noted that only the wealthiest quartile of consumers has more savings compared to early 2019, while those in lower FICO score bands are experiencing increased borrowing and declining payment rates due to inflation and high interest rates.
The Federal Reserve has maintained interest rates at a range of 5.25-5.5%, the highest level in 23 years, as it monitors inflation measurements that aim to approach the central bank’s 2% target before implementing desired rate cuts.
Despite banks bracing for potential defaults in the latter half of the year, current default rates do not indicate an imminent consumer crisis, according to experts. Brian Mulberry emphasized the distinction between homeowners and renters during the pandemic, noting that homeowners who locked in low fixed rates are not feeling as much financial pressure compared to renters.
With rent prices rising over 30% nationwide since 2019 and grocery costs increasing by 25%, renters without the benefit of fixed-rate mortgages face substantial strain on their budgets.
Overall, analysts suggest there were no significant changes in asset quality during the latest earnings reports. Strong revenues and net interest income continue to signal a healthy banking sector, with some experts expressing relief that the financial system remains robust despite the persistent high interest rates.