As interest rates remain at levels not seen in over 20 years and inflation continues to affect consumers, major banks are gearing up to face 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 funds that financial institutions set aside to cover potential losses from credit risks, including defaults on loans and bad debts, notably in sectors like commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, more than tripling its reserves from the prior quarter, and Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier environment, where both secured and unsecured loans might lead to significant losses. According to the New York Fed, U.S. households currently owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise as consumers exhaust their pandemic savings and increasingly rely on credit. In the first quarter of this year, credit card balances surpassed $1 trillion for the second consecutive quarter, as reported by TransUnion. Furthermore, the commercial real estate sector remains in a precarious situation.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted that the banking sector and consumer health are still dealing with the aftermath of the COVID era, particularly as stimulus measures begin to wane.
Experts warn that the challenges for banks may intensify in the upcoming months. Mark Narron, a senior director with Fitch Ratings, explained that the provisions reported by banks reflect their expectations for future credit quality rather than past performance.
Currently, banks anticipate a slowdown in economic growth, an increase in unemployment, and potential interest rate cuts later this year, which may lead to higher delinquency and default rates as 2023 progresses.
Mark Mason, Citi’s chief financial officer, highlighted concerns particularly among lower-income consumers, who have seen their savings diminished since the pandemic. He stated that while the overall U.S. consumer remains resilient, spending and payment patterns are increasingly divergent based on income and credit scores.
The Federal Reserve has maintained interest rates at a two-decade high of 5.25-5.5% while awaiting stabilization in inflation metrics towards their 2% target before considering any anticipated rate cuts.
Despite banks preparing for potential defaults, experts suggest that current rates of default do not yet indicate an impending consumer crisis. Mulberry pointed out a distinction between homeowners and renters during the pandemic. While homeowners secured low fixed-rate mortgages, renters faced rising costs and increased stress on their budgets due to steep rent increases and inflation.
Overall, the latest earnings reports indicate that asset quality remains stable, with strong revenues and profits suggesting a healthy banking sector. Mulberry emphasized the resilience of the banking system but noted the ongoing stress caused by sustained high-interest rates, which may impact the financial landscape moving forward.