With interest rates reaching levels not seen in over two decades and inflation continuing to impact consumers, major banks are bracing for heightened risks associated with their lending activities.
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 that banks set aside to account for potential losses from credit risks, which include non-performing loans and commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses rose significantly to $21.8 billion, more than three times its previous reserve, and Wells Fargo reported $1.24 billion in provisions.
These increased reserves indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans may lead to greater losses. A recent analysis by the New York Fed revealed that U.S. households have accumulated $17.7 trillion in debt from consumer loans, student loans, and mortgages.
Credit card use is also on the rise, with delinquency rates climbing as consumers, having exhausted pandemic-related savings, increasingly rely on credit. TransUnion reported that credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that totals exceeded a trillion dollars. Additionally, the commercial real estate sector remains vulnerable.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the financial health of consumers remains influenced by stimulus measures from the pandemic.
However, potential challenges for banks may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, pointed out that quarterly provisions do not solely reflect recent credit quality but also banks’ expectations for future conditions. He noted a shift from a historical model where rising defaults prompted higher provisions to a more forward-looking approach driven by macroeconomic forecasts.
In the short term, banks are anticipating slower economic growth, an increase in unemployment, and two interest rate cuts later this year. This outlook could lead to a rise in delinquencies and defaults by year’s end.
Citi’s CFO, Mark Mason, highlighted that issues appear to be more pronounced among lower-income consumers, who have seen their savings shrink post-pandemic. While the overall U.S. consumer remains resilient, Mason observed that only the highest income quartile has maintained increased savings since early 2019.
The Federal Reserve is holding interest rates at a 23-year high of 5.25-5.5% while monitoring inflation trends, aiming for stabilization toward a 2% target before implementing anticipated cuts.
Despite preparations for increased defaults in the latter half of the year, Mulberry noted that current default rates do not signal an imminent consumer crisis. He remarked on the differences in impacts between homeowners and renters during the pandemic; homeowners benefitted from fixed low rates, while renters are now facing significant financial strain due to rising rent and grocery costs.
For the time being, the key takeaway from the latest earnings reports is that asset quality remains stable. Narron observed that strong revenues and profits, as well as resilient net interest income, are positive signs for the banking industry.
Mulberry emphasized the ongoing strength of the financial system but cautioned that prolonged high-interest rates could introduce further stress in the future.