With interest rates at their highest levels in over 20 years and inflation impacting consumers, major banks are bracing for potential risks associated with their lending practices.
In the second quarter of the year, 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 safeguard against potential losses from credit risks, including overdue debts and 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’s allowance for credit losses reached $21.8 billion by the end of the quarter, significantly up from previous quarters. Wells Fargo contributed $1.24 billion to its provisions.
These increased reserves indicate that banks are preparing for a challenging financial environment, where both secured and unsecured loans may lead to greater losses. The New York Fed recently reported that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise as consumers deplete their pandemic-era savings and turn to credit to manage expenses. Credit card balances hit $1.02 trillion in the first quarter, marking the second consecutive quarter where total balances exceeded this threshold. Commercial real estate (CRE) remains a particularly vulnerable sector.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking and consumer health landscape is still recovering from the impacts of COVID-19, largely due to prior stimulus measures.
Experts suggest that current provisions do not necessarily reflect immediate credit quality, but rather banks’ expectations regarding future performance. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that the approach to provisioning has shifted towards being more influenced by macroeconomic forecasts than by immediate loan performance.
In the near future, banks anticipate slower economic growth, increased unemployment, and possible interest rate cuts in September and December, which could lead to additional delinquencies and defaults as the year ends.
Citi’s CFO, Mark Mason, highlighted that the financial challenges are most pronounced among lower-income consumers, whose savings have diminished post-pandemic. He noted that only the highest income quartile has more savings than they did at the start of 2019, while customers with lower credit scores are experiencing declines in payment rates and are borrowing more due to the pressures of inflation and rising interest rates.
The Federal Reserve continues to maintain interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation towards its 2% target before implementing expected rate cuts.
Although banks are preparing for possible increased defaults later in the year, current default rates do not indicate an imminent consumer crisis. Observations focus on the differences between homeowners and renters during the pandemic, as homeowners secured low fixed-rate mortgages, insulating them from immediate economic strain, unlike renters who are facing sharply rising costs.
Despite rising stresses on budgets, especially for renters, the overall health of the banking sector remains robust. According to experts, current earnings reports reveal no significant new issues regarding asset quality. Strong revenues, profits, and net interest income are encouraging signs for the banking industry’s stability, suggesting that it is navigating these challenging conditions effectively, although continued vigilance is essential as high interest rates persist.