As interest rates remain at their highest levels in over two decades and inflation persists, major banks are bracing for increased risks associated with lending practices.
In the recent quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions are reserves set aside by financial institutions to cover potential losses from credit risks, including bad debts and loans, particularly in commercial real estate.
JPMorgan raised its credit loss provisions by $3.05 billion in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, more than tripling its reserves from the previous quarter, and Wells Fargo set aside $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans could lead to larger losses. An analysis of household debt by the New York Fed suggests that Americans hold a collective $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, credit card issuance and delinquency rates are also on the rise as consumers exhaust their pandemic savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where totals surpassed the trillion-dollar mark, according to TransUnion. The commercial real estate sector also continues to face challenges.
Brian Mulberry, a portfolio manager at Zacks Investment Management, commented on the ongoing effects of the COVID-19 pandemic and the stimulus measures that had supported consumers during that period.
Experts warn that any potential banking issues may arise in the months to come. Mark Narron, a senior director at Fitch Ratings, explained that a bank’s quarterly provisions reflect future expectations rather than past credit quality, signaling a shift in how provisions are determined based on macroeconomic forecasts.
In the short term, banks anticipate slowing economic growth, an increase in the unemployment rate, and two expected interest rate cuts later this year in September and December, which may lead to rising delinquencies and defaults.
Citi’s chief financial officer, Mark Mason, highlighted that the emerging financial pressures are particularly felt among lower-income consumers who have depleted their savings post-pandemic. He noted that only the highest income quartile has maintained greater savings compared to early 2019, with consumers possessing high credit scores driving spending while those with lower scores are struggling with dropping payment rates.
The Federal Reserve continues to maintain interest rates at a 23-year high of 5.25-5.5%, pending stabilization of inflation toward its 2% target before implementing anticipated cuts.
Despite projections for increased defaults in the latter half of the year, Mulberry stated that current default rates do not indicate a full-blown consumer crisis. He emphasized the difference in financial stress between homeowners and renters. Homeowners, who secured low fixed rates on their loans during the pandemic, are less affected by rising rates, while renters face significant challenges due to skyrocketing rental prices.
Currently, the recent earnings reports do not reveal new issues concerning asset quality, according to Narron. He noted that strong revenue, profit, and net interest income figures indicate a still-resilient banking sector. Mulberry also acknowledged the robustness of the financial system but cautioned that prolonged high-interest rates could introduce increasing stress.