As interest rates reach levels not seen in over two decades and inflation pressures continue to affect consumers, major banks are bracing 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 are the funds that banks set aside to cover anticipated losses from credit risk, including bad debts and delinquent loans, with a particular focus on commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit losses, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, marking a substantial increase from the previous quarter, and Wells Fargo reported provisions of $1.24 billion.
This increase in reserves indicates that banks are preparing for a more volatile lending environment, where both secured and unsecured loans may lead to greater losses. A recent report from the New York Federal Reserve revealed that total household debt in the U.S. has climbed to $17.7 trillion across various types of loans, including consumer and student loans as well as mortgages.
Credit card use and delinquency rates have also begun to rise as individuals deplete their pandemic savings and turn increasingly to credit. In the first quarter of this year, credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. The state of commercial real estate also remains uncertain.
Brian Mulberry, a portfolio manager at Zacks Investment Management, highlighted the impact of COVID-19 on consumer behavior and banking practices, noting that much of the current financial health can be attributed to previous stimulus efforts.
However, challenges for banks are anticipated in the future. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that quarterly provisions do not necessarily reflect past credit quality but rather banks’ expectations for future conditions.
Currently, banks forecast sluggish economic growth, rising unemployment, and two potential interest rate cuts later this year, which could lead to increased delinquencies and defaults as 2023 comes to a close.
Citigroup’s CFO, Mark Mason, pointed out that the signs of financial stress are particularly evident among lower-income consumers whose savings have diminished since the pandemic. He noted that only the highest income earners have seen an increase in savings since early 2019, while customers with lower credit scores are facing challenges in payment rates and are increasingly borrowing due to inflation and high interest rates.
With the Federal Reserve maintaining interest rates at a 23-year high of 5.25-5.5%, there is anticipation for rate cuts once inflation stabilizes towards the Fed’s 2% target.
Despite the preparations for potential defaults, Mulberry indicated that current default rates do not yet suggest a consumer crisis. He mentioned that homeowners who secured low fixed mortgage rates during the pandemic are largely insulated from the current economic pressures, contrasting with renters who face rising housing costs without comparable wage growth.
The recent earnings reports suggest that there are no significant new concerns regarding asset quality in the banking sector. Revenues, profits, and net interest income remain strong, reflecting a still-healthy financial system. Mulberry noted that while the banking sector shows resilience, prolonged high interest rates may introduce further stress in the future.