As interest rates remain at their highest levels in over two decades and inflation continues to put pressure on consumers, major banks are bracing for increased risks in 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 are funds that banks set aside to cover potential losses from loan defaults, including troubled debt and 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 reached $21.8 billion at the end of June, nearly tripling its reserves from the previous quarter, and Wells Fargo reserved $1.24 billion.
These provisions signal that banks are preparing for a riskier lending environment, with both secured and unsecured loans potentially leading to greater losses. The New York Federal Reserve recently reported that American households owe a staggering $17.7 trillion across various types of loans, including consumer and student loans, as well as mortgages.
Credit card issuance and delinquency rates are also rising, as consumers deplete their pandemic-era savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total balances surpassed the trillion-dollar mark, according to TransUnion. The commercial real estate sector is also facing significant challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the long-lasting effects of the COVID era and extensive stimulus measures have played a role in these dynamics.
However, the challenges that banks may encounter are projected to materialize in the coming months. According to Mark Narron, a senior director at Fitch Ratings, the provisions banks report do not solely reflect recent credit quality but instead indicate expectations for the future.
As banks anticipate slowing economic growth, higher unemployment, and potential interest rate cuts later this year, they may face rising delinquencies and defaults.
Citigroup’s CFO Mark Mason highlighted that the warning signs are especially evident among lower-income consumers, many of whom have seen their savings diminish since the pandemic began. He pointed out that only the highest income quartile maintains greater savings than before 2019, with consumers in lower credit score brackets exhibiting declining payment rates and increased borrowing due to the impact of high inflation and interest rates.
With the Federal Reserve holding interest rates at a level of 5.25-5.5% as it waits for inflation to stabilize toward its target of 2%, the banking sector is preparing for potential defaults in the latter half of the year. However, Mulberry noted that current default rates do not suggest an imminent consumer crisis.
He observed a distinction between homeowners during the pandemic, who locked in low fixed-rate mortgages, and renters who are facing increased rental costs, which have risen over 30% nationwide since 2019.
For the time being, the latest earnings reports indicate that there are no alarming changes in asset quality. Strong revenues, profits, and robust net interest income suggest that the banking sector remains healthy. Mulberry emphasized that the resilience of the financial system is noteworthy, although ongoing high interest rates could create more pressure moving forward.