As interest rates remain at their highest levels in over two decades and inflation continues to impact consumers, major banks are preparing for increased risks in their lending operations.
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 that financial institutions allocate to account for potential losses from credit risks, including bad debts and lending practices related to commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, more than tripling its reserves from the prior quarter. Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves indicate that banks are bracing themselves for a more challenging environment, where both secured and unsecured loans could lead to greater losses. A recent analysis by the New York Fed highlighted that Americans collectively owe $17.7 trillion in various consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as consumers deplete their pandemic-era savings and increasingly rely on credit. In the first quarter, total credit card balances exceeded $1 trillion for the second consecutive quarter, according to TransUnion. The CRE sector remains particularly vulnerable.
Financial experts indicate that the current economic conditions stem from the COVID-19 pandemic and the stimulus measures that boosted consumer finances. However, any potential issues for banks are likely to materialize 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.
Looking ahead, banks are forecasting slower economic growth, a rise in unemployment, and two anticipated interest rate cuts later this year. This could result in an increase in delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, noted that the emerging concerns are particularly evident among lower-income consumers, who have seen their savings diminish since the pandemic began.
“While we continue to see an overall resilient U.S. consumer, there is a noticeable difference in performance and behavior across various income levels,” Mason stated. He added that only high-income consumers have managed to accumulate more savings since early 2019, while those with lower FICO scores are struggling more under the pressure of rising inflation and interest rates.
The Federal Reserve currently holds interest rates at a 5.25-5.5% range, the highest in 23 years, as it awaits stabilization in inflation rates toward the central bank’s target of 2% before implementing expected rate cuts.
Despite banks preparing for a potential rise in defaults later this year, current default rates do not suggest a consumer crisis is imminent, according to analysts. Observers are also noted to consider the differences between homeowners and renters since the pandemic began.
While interest rates have climbed significantly, homeowners typically secured low fixed rates during that period and thus are not feeling the financial strain as much. In contrast, renters have faced over a 30% increase in rents nationwide since 2019 and are struggling with rising grocery costs as well.
For now, the prevailing sentiment from the latest earnings reports is that there are no alarming signs concerning asset quality. With strong revenues, profits, and resilient net interest income, the banking sector appears to be stable.
“There is some strength in the banking sector that is reassuring, indicating that the financial system remains strong and sound at this time,” noted Mulberry. However, he cautioned that prolonged high interest rates could eventually lead to increased financial stress.