Big banks are bracing for increased risks in their lending practices as interest rates remain at highs not seen in over two decades and inflation pressures consumers. During the second quarter, major financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their provisions for credit losses compared to the previous quarter. These provisions represent the funds banks allocate to cover potential losses from credit risks, including bad debts and delinquencies from lending activities.
JPMorgan amassed $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, more than tripling their reserves from the prior quarter, and Wells Fargo’s provisions totaled $1.24 billion.
These increased reserves signal that banks are preparing for a riskier economic environment where both secured and unsecured loans could lead to greater losses. An analysis by the New York Federal Reserve indicated that American households hold a combined debt of $17.7 trillion in consumer, student, and mortgage loans.
Additionally, credit card issuance and delinquency rates are rising as consumers tap into their savings, which were bolstered during the pandemic. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector is also facing challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the ongoing transition from the COVID era, suggesting that stimulus measures have so far masked the financial health of consumers.
Experts note that the provisions banks establish do not solely reflect recent credit quality; rather, they are indicative of future expectations. Mark Narron from Fitch Ratings explained, “The macroeconomic forecast truly drives provisioning now,” emphasizing that the current environment may lead to more delinquencies and defaults as economic growth slows and unemployment rises.
Citigroup’s CFO Mark Mason highlighted that financial strains are particularly evident among lower-income consumers, who have seen their savings diminish post-pandemic. He pointed out that only the highest income quartile has managed to retain greater savings since early 2019, while those with lower credit scores are increasingly struggling with payment rates.
With the Federal Reserve maintaining interest rates at a 23-year high of 5.25-5.5%, it awaits stabilization of inflation towards its 2% target before considering rate cuts.
While banks anticipate rising defaults in the latter half of the year, Mulberry noted that current default rates do not point to a consumer crisis at this time. He speculated that homeowners, who secured low fixed-rate mortgages, are less affected by rising rates compared to renters, who have faced a surge in rental costs.
Despite the challenges, the latest earnings reports indicated no significant deterioration in asset quality for the banks. Strong revenue, profit levels, and net interest income point towards a resilient banking sector. Mulberry stated that although the banking system remains robust, prolonged high-interest rates could increase stress on financial institutions.