As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for heightened risks associated with their lending activities.
In the second quarter, prominent banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions are financial reserves set aside to mitigate potential losses stemming from credit risks, such as delinquent debts and commercial real estate loans.
JPMorgan allocated $3.05 billion in credit loss provisions during the second quarter, while Bank of America set aside $1.5 billion. Citigroup reported a total of $21.8 billion in credit loss reserves by the end of the quarter, which more than tripled its previous quarter’s reserves, and Wells Fargo recorded provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier lending environment, where losses may arise from both secured and unsecured loans. A recent analysis by the New York Federal Reserve revealed that total American household debt has surged to $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise as consumers deplete their savings accumulated during the pandemic and increasingly rely on credit. TransUnion reported that credit card balances exceeded $1 trillion for the second consecutive quarter, while commercial real estate remains in a precarious state.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted that the banking landscape is still affected by the ramifications of the COVID-19 pandemic, particularly regarding the stimulus measures that boosted consumer spending.
Looking ahead, analysts advise that current provisions may not fully represent credit quality from the preceding quarter but rather reflect banks’ expectations for potential future outcomes. Mark Narron, a senior director at Fitch Ratings, emphasized that the shift to a macroeconomic forecast-driven provisioning approach signifies that banks anticipate challenges ahead.
In the short term, banks expect slowing economic growth, rising unemployment rates, and potential interest rate cuts in September and December, which could lead to increased delinquencies and defaults as the year concludes.
Mark Mason, Citi’s chief financial officer, highlighted that warning signs are particularly pronounced among lower-income consumers, who have seen their savings diminish since the pandemic began. He indicated that only the highest income quartile has managed to increase their savings since early 2019, while those with lower credit scores are facing sharper declines in payment rates and are borrowing more due to the effects of inflation and high interest rates.
The Federal Reserve continues to maintain interest rates at a 23-year high, with current rates between 5.25% and 5.5%, awaiting stabilization in inflation before considering any rate cuts.
Despite banks preparing for a potential rise in defaults, the current levels of defaults do not suggest an imminent consumer crisis. Brian Mulberry pointed out the distinction between homeowners and renters, noting that homeowners benefiting from fixed, low interest rates from the pandemic are less affected by rising rates, while renters face greater challenges as their rent has increased significantly, outpacing wage growth.
For the moment, the earnings reports from banks reveal no substantial shifts in asset quality, with robust revenues, profits, and steady net interest income reflecting a healthy banking sector. Analysts believe that while some strength in the banking sector is apparent, sustained high interest rates may increase financial stress in the future.