Big banks are bracing themselves for increasing risks associated with their lending as interest rates reach a two-decade high and inflation continues to pressure consumers. In the second quarter, major financial institutions, including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo, have all raised their provisions for credit losses compared to the previous quarter. These provisions are funds set aside to cover potential losses from credit risks, such as delinquent debts and commercial real estate loans.
JPMorgan increased its provision for credit losses by $3.05 billion in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses rose significantly, totaling $21.8 billion by the end of the quarter, which was over three times its reserve build from the previous quarter. Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging lending environment, anticipating larger losses from both secured and unsecured loans. An analysis from the New York Fed revealed that American households collectively owe $17.7 trillion in various consumer debts, including student loans and mortgages.
Moreover, credit card issuance and delinquency rates are climbing as consumers deplete their pandemic-era savings and increasingly rely on credit. As of the first quarter, credit card balances reached $1.02 trillion, marking the second consecutive quarter where the total exceeded the trillion-dollar milestone. Additionally, the commercial real estate sector remains under pressure.
Financial experts express concern about the effects of the prolonged COVID-19 pandemic. Brian Mulberry from Zacks Investment Management noted that the stimulus efforts during the pandemic heavily influenced consumer health. However, potential challenges for banks are expected to emerge in the coming months.
Mark Narron, a senior director at Fitch Ratings, pointed out that current provisions may not accurately represent credit quality from the last three months but instead reflect banks’ expectations for the future. He indicated that banks anticipate slower economic growth, higher unemployment rates, and expected interest rate cuts in September and December, which could lead to increased delinquencies and defaults as the year concludes.
Citi’s CFO, Mark Mason, highlighted growing concerns among lower-income consumers, who have seen their savings diminish since the pandemic began. He noted that only the highest income quartile has managed to retain more savings than before 2019. Lower-income individuals with lower credit scores are experiencing sharper declines in payment rates and are borrowing more due to the impact of rising inflation and interest rates.
Currently, the Federal Reserve maintains interest rates at a 23-year high of 5.25-5.5%, waiting for inflation to stabilize at its 2% target before proceeding with expected rate cuts.
Despite the banks preparing for potential defaults in the latter half of the year, Mulberry reassured that defaults have not yet escalated to levels indicative of a consumer crisis. He is monitoring the contrast between homeowners and renters during this period. He noted that although interest rates have increased significantly, homeowners have locked in low fixed rates for their debts, which shields them from immediate financial strain. In contrast, renters, who did not have the same opportunity, are facing significant stress due to rising rents and grocery costs.
Overall, strong revenues, profits, and stable net interest income suggest that the banking sector remains healthy, according to financial experts. Narron commented that the recent earnings reports showed no new issues concerning asset quality. However, ongoing high interest rates could lead to increased stress for the banks in the future.