With interest rates reaching over two-decade highs and inflation pressuring consumers, major banks are gearing up for increased risks associated with their lending practices.
In the second quarter, major financial institutions including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions are funds that banks set aside to address potential losses due to credit risks, such as overdue debts and bad loans, including those tied to commercial real estate.
JPMorgan allocated $3.05 billion for credit loss provisions in Q2, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses amounted to $21.8 billion at the end of the quarter, more than tripling its reserves from the previous quarter. Wells Fargo had provisions totaling $1.24 billion.
These increased reserves indicate that banks are preparing for a potentially riskier lending landscape, as both secured and unsecured loans could lead to larger losses. A New York Fed analysis revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also climbing as pandemic savings diminish, leading consumers to rely more heavily on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total balances exceeded the trillion-dollar mark. Meanwhile, commercial real estate continues to face uncertainty.
Brian Mulberry from Zacks Investment Management noted that the banking sector and consumer health are still emerging from the impact of COVID, largely fueled by significant stimulus measures provided during the pandemic.
However, any significant banking challenges are anticipated in the coming months. Mark Narron from Fitch Ratings explained that the provisions reported each quarter do not necessarily reflect recent credit quality but rather banks’ expectations for future performance.
In the short term, banks are forecasting slower economic growth, rising unemployment, and potential interest rate cuts later this year, which may lead to higher delinquency rates and defaults by year-end.
Citigroup’s CFO Mark Mason observed that concerning trends are primarily affecting lower-income consumers, who have seen their savings decline post-pandemic. He noted that only the highest income quartile has managed to save more compared to the beginning of 2019, with those in the lower FICO score bands experiencing a sharp decline in payment rates and increasing borrowing, influenced by ongoing inflation and elevated interest rates.
The Federal Reserve has maintained interest rates at 5.25-5.5%, the highest level in 23 years, waiting for inflation to stabilize toward its 2% target before implementing anticipated rate reductions.
Although banks are preparing for broader defaults later in the year, current default rates do not indicate a consumer crisis. Mulberry emphasized the difference in experiences between homeowners and renters during this period. Homeowners, who secured low fixed-rate mortgages, are less affected by rising rates, while renters face significant budget pressures due to soaring rental costs.
As of now, analysts note that there were no significant new issues in asset quality this quarter. Strong revenue, profits, and net interest income continue to reflect a healthy banking sector, with Mulberry affirming that the financial system remains robust at this time, albeit under scrutiny as prolonged high interest rates could lead to more stress.