With interest rates at their highest in over two decades and ongoing inflation pressures on consumers, major banks are gearing up to manage increased lending risks.
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 represent the funds that banks set aside to cover potential losses stemming from credit risks, including defaults and bad debts, particularly in the realm of commercial real estate loans.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses rose to $21.8 billion by the end of the quarter, more than tripling its reserves from the previous quarter. Wells Fargo recorded provisions of $1.24 billion.
These increases indicate that banks are preparing for a riskier lending environment, where both secured and unsecured loans may result in significant losses. The New York Federal Reserve recently reported that U.S. households owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as consumers exhaust their pandemic savings and increasingly rely on credit. TransUnion reported that credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter that total cardholder balances surpassed the trillion-dollar threshold. Meanwhile, commercial real estate (CRE) remains unsettled.
According to Brian Mulberry, a portfolio manager at Zacks Investment Management, the banking sector is still emerging from the COVID-19 era, largely due to significant stimulus measures directed at consumers.
However, the real challenges for banks may unfold in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that current provisions may not accurately reflect credit quality from the previous quarter, but rather banks’ expectations for future trends.
Narron pointed out that rather than reacting to immediate loan defaults, banks now base their provisioning on broader economic forecasts. In the short term, banks anticipate slower economic growth, increased unemployment, and two potential interest rate cuts later this year, which could lead to more delinquencies and defaults as the year ends.
Citi’s CFO Mark Mason remarked that these concerning trends are particularly pronounced among lower-income consumers, who have seen their savings diminish since the pandemic. He emphasized that while the overall U.S. consumer remains resilient, performance and behavior vary significantly across different income levels.
Mason further noted that only the top income quartile has managed to save more than they did at the beginning of 2019, and consumers with high credit scores are primarily driving spending and maintaining good payment rates. Conversely, lower-scoring consumers are experiencing sharp declines in payment rates and increasing their borrowing due to the strain of high inflation and interest rates.
Despite banks bracing for potential defaults, Mulberry indicated that current defaults are not escalating at a level indicative of a consumer crisis. He is particularly focused on comparing the experiences of homeowners and renters during this period. Homeowners locked in low fixed rates on their debts, potentially shielding them from immediate financial distress, whereas renters face significant challenges with rising rental costs, which have surged over 30% nationwide since 2019.
As of now, the key takeaway from the latest earnings reports is that there are no alarming signs regarding asset quality. Strong revenues, profits, and stable net interest income suggest that the banking sector remains robust. Mulberry expressed cautious optimism about the health of the financial system, emphasizing the need for vigilance as elevated interest rates could lead to increased stress in the future.