Major banks are bracing for potential risks in their lending practices as interest rates remain at their highest level in over two decades and inflation continues to affect consumers. 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 funds set aside to cover potential losses from credit risks, which include delinquent loans and bad debts, particularly in the commercial real estate sector.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup recorded an allowance for credit losses totaling $21.8 billion, significantly increasing its reserves from the previous quarter, and Wells Fargo’s provisions reached $1.24 billion.
These increased reserves indicate that the banks are preparing for a more challenging lending environment, where both secured and unsecured loans may lead to larger losses. According to a recent analysis by the New York Fed, American consumers collectively owe approximately $17.7 trillion in various loans, including consumer, student, and mortgage debts.
Credit card issuance is on the rise, along with delinquency rates, as many consumers deplete their savings accumulated during the pandemic and turn to credit for support. Total credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that exceeded the trillion-dollar threshold. The commercial real estate sector is also in a delicate situation.
Experts suggest that the financial industry is still adjusting from the impacts of the COVID-19 pandemic, particularly with the economic stimulus measures that were provided to consumers. However, the real concerns for banks will emerge in the coming months.
“The provisions seen in any quarter do not solely reflect credit quality from the previous three months; they also represent banks’ expectations for the future,” stated Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group. He noted that the landscape has shifted from a traditional approach where increased loan delinquencies prompted higher provisions to one where macroeconomic forecasts largely influence provisioning.
In the short term, banks anticipate a slowdown in economic growth, an increase in unemployment, and potential interest rate cuts later this year. This could result in more delinquencies and defaults as the year concludes.
Citi’s CFO, Mark Mason, pointed out that the challenges are primarily affecting lower-income consumers who have seen their savings diminish since the pandemic. While the overall U.S. consumer remains resilient, disparities exist based on income level. Only the highest income quartile has maintained or increased their savings since 2019, with those having credit scores over 740 significantly contributing to spending growth. In contrast, consumers with lower credit scores are experiencing a decline in payment rates and increased borrowing, particularly amid rising inflation and interest rates.
The Federal Reserve has set interest rates at a 23-year high of 5.25-5.5% as it monitors inflation trends, holding off on anticipated cuts until stability is achieved.
Despite preparations for a potential rise in defaults, current data does not indicate an impending consumer crisis. Experts are observing differences between homeowners and renters from the pandemic period. Homeowners who secured low fixed rates on their mortgages are less affected by interest rate increases, while renters are facing substantial pressure due to higher rents and rising grocery costs.
For now, the earnings reports show nothing alarming regarding asset quality. Strong revenues, profits, and healthy net interest income reflect a banking sector that remains robust. Analysts are keeping a close eye on the situation, acknowledging that maintaining high interest rates could lead to increased stress on financial institutions in the longer term.