As interest rates reach their highest levels in over two decades and inflation continues to affect consumers, major banks prepare for increased risks associated with their lending practices.
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 the funds set aside by financial institutions to address potential losses from credit risk, including delinquent debts and issues surrounding commercial real estate loans.
JPMorgan allocated $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 surged to $21.8 billion, more than tripling its reserve from the prior quarter, and Wells Fargo’s provisions totaled $1.24 billion.
These increased provisions indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans may lead to greater losses. A recent analysis from the New York Federal Reserve revealed that Americans collectively owe approximately $17.7 trillion across various types of loans, including consumer, student, and mortgage loans.
Furthermore, the issuance of credit cards and the corresponding delinquency rates are on the rise as consumers deplete their savings accumulated during the pandemic and increasingly rely on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter in which they surpassed the trillion-dollar mark, according to TransUnion. Additionally, the commercial real estate market remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, highlighted the lingering effects of the COVID-19 era on banking and consumer health, attributing much of the current situation to the stimulus measures provided to consumers.
Experts warn, however, that banks may encounter more difficulties in the near future. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that a bank’s provisions for any given quarter do not necessarily reflect recent credit quality but are instead based on future expectations.
Navigating potential economic slowdown, increased unemployment rates, and anticipated interest rate reductions later in the year, banks may anticipate a rise in delinquencies and defaults as the year closes.
Citi’s chief financial officer, Mark Mason, noted that the issues appear particularly pronounced among lower-income consumers, who have gradually depleted their savings since the pandemic’s onset. He observed that only the highest-income quartile has managed to retain more savings than they had in 2019, while those with lower credit scores are facing greater financial strain.
As the Federal Reserve maintains interest rates at a 23-year high of 5.25-5.5%, analysts are awaiting stabilization of inflation measures to reach the central bank’s 2% target before possible rate cuts occur.
Despite banks anticipating increased defaults in the latter part of the year, the current rate of defaults does not indicate a consumer crisis, according to Mulberry. He is particularly attentive to the distinction between individuals who owned homes during the pandemic and those who rented.
While rates have significantly increased, homeowners who locked in low fixed-rate loans have yet to experience substantial financial strain. In contrast, renters, who have not had the opportunity to secure low rates, are grappling with rent increases of over 30% nationwide since 2019 and rising grocery costs.
Despite these stresses, the latest earnings reports suggest that the banking sector remains stable. Narron noted that there were no new concerns regarding asset quality this quarter, and many indicators, such as strong revenues and net interest income, reflect a healthy banking environment.
Mulberry remarked on the resilience of the financial system but cautioned that prolonged high interest rates could lead to increased stress.