With interest rates reaching levels not seen in over 20 years and inflation continuing to challenge consumers, major banks are bracing for increased risks tied to 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 the funds that banks reserve to cover potential losses from credit risks, including overdue debts and problematic loans, particularly in the commercial real estate sector.
JPMorgan set aside $3.05 billion for credit losses, while Bank of America allocated $1.5 billion. Citigroup’s credit loss allowance reached $21.8 billion at the end of the quarter, significantly more than its previous amount, and Wells Fargo made provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a more risky lending environment, where both secured and unsecured loans could lead to greater losses. According to a recent report from the New York Federal Reserve, total household debt in the U.S. has climbed to $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
There has also been a rise in credit card issuance and delinquency rates as consumers exhaust their savings from the pandemic and turn more to credit. Credit card balances hit $1.02 trillion in the year’s first quarter, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold. The commercial real estate market remains vulnerable.
As highlighted by Brian Mulberry from Zacks Investment Management, the banking sector is still emerging from the impact of the COVID-19 pandemic, which was significantly influenced by stimulus measures provided to consumers.
However, challenges for banks are expected in the coming months. Mark Narron from Fitch Ratings explained that the provisions reported in any given quarter do not necessarily reflect the previous three months’ credit quality but instead indicate banks’ expectations for the future.
He noted, “We’ve transitioned from a situation where provisions increased as loans began to default, to one where macroeconomic forecasts primarily guide provisioning.”
Looking ahead, banks anticipate slower economic growth, rising unemployment rates, and potential interest rate cuts this September and December. This situation could lead to increased delinquencies and defaults as the year closes.
Citi’s chief financial officer Mark Mason pointed out that these warning signs seem concentrated among lower-income consumers who have seen their savings decline since the pandemic. He noted a disparity in financial recovery, with only higher-income individuals having more savings compared to early 2019.
Mason stated, “It’s the higher income earners who are driving spending growth and maintaining high payment rates, whereas those with lower credit scores are experiencing significant drops in payment rates and are borrowing more due to the effects of rising inflation and interest rates.”
The Federal Reserve has maintained interest rates at a high of 5.25-5.5% as it waits for inflation to stabilize toward its 2% target before implementing any anticipated cuts.
While banks are preparing for potential defaults later this year, defaults have not yet escalated to levels indicative of a consumer crisis, according to Mulberry. He is particularly monitoring the differences in financial pressures between homeowners and renters.
Mulberry noted that while interest rates have sharply increased, homeowners who secured low fixed rates are still financially stable. In contrast, renters, who did not benefit from locked-in rates, are facing significant pressures from increased rental costs and rising grocery prices, which have surged over 30% and 25%, respectively, since 2019.
Despite the cautious outlook, the latest earnings reports for banks reveal no significant new concerns regarding asset quality. Strong revenues and profits as well as healthy net interest income suggest the banking sector remains robust.
Mulberry acknowledged, “The strength indicated in the banking sector is somewhat reassuring, confirming that the foundations of the financial system are still solid at this time. However, attention must be paid, as prolonged high interest rates could lead to increased strain.”