With interest rates reaching their highest levels in over twenty years and inflation continuing to pressure consumers, major banks are bracing for increased risks in their lending practices.
In the second quarter, leading banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks set aside to address potential losses stemming from credit risk, which may include delinquent loans and other forms of debt, particularly in the commercial real estate sector.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s reserves rose to $21.8 billion, more than tripling its build from the prior quarter; and Wells Fargo’s provisions reached $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier lending environment, where both secured and unsecured loans could lead to greater losses. A recent analysis from the New York Federal Reserve reported that U.S. households owe a total of $17.7 trillion in consumer, student, and mortgage loans.
Credit card issuance, as well as delinquency rates, are also on the rise, as consumers draw on their savings accumulated during the pandemic. According to TransUnion, credit card balances surpassed the $1 trillion mark for the second consecutive quarter, totaling $1.02 trillion in the first quarter of this year. Additionally, the commercial real estate market remains unstable.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted that the banking sector is still adjusting from the COVID era, heavily influenced by the federal stimulus provided to consumers.
Challenges for banks are anticipated in the upcoming months. Mark Narron of Fitch Ratings emphasized that quarterly provisions reflect banks’ forecasts rather than current credit quality, indicating a shift towards macroeconomic expectations driving provisions rather than simply reacting to defaults.
Looking ahead, banks predict slowing economic growth, an increase in unemployment rates, and two anticipated interest rate cuts this year in September and December, all of which could lead to a rise in delinquencies and defaults.
Citi’s CFO, Mark Mason, pointed out that concerns are notably present among lower-income consumers, who have seen their savings diminish since the pandemic.
“Though we observe a generally resilient U.S. consumer, performance varies significantly across income levels,” Mason stated. He noted that only the top income quartile has increased savings since early 2019, with those in higher credit score brackets maintaining growth in spending and payment rates, while lower-scoring customers are experiencing declines in payments and increased borrowing due to rising inflation and interest rates.
The Federal Reserve holds interest rates at a 23-year high of 5.25-5.5%, awaiting inflationary stability close to its 2% target before implementing anticipated rate cuts.
Despite preparations for a potential rise in defaults, indicators do not yet suggest an alarming consumer crisis. Mulberry highlighted the distinction between homeowners and renters during the pandemic, noting that those who locked in low fixed mortgage rates are less affected by current economic pressures compared to renters facing substantial increases in rent.
Recent earnings reports show no alarming new trends in asset quality, according to Narron, who found that strong revenues, profits, and net interest income contribute to a generally healthy banking sector. Mulberry added that while there is resilience in the banking system, sustained high interest rates may increase stress over time.