As interest rates soar to levels not seen in over 20 years and inflation continues to strain consumers, major banks are bracing for heightened risks associated with their lending operations.
In the second quarter, major financial institutions including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their reserves for potential credit losses compared to the previous quarter. These reserves are funds allocated by banks to manage possible losses from credit risk such as defaults on loans, including those related to commercial real estate.
JPMorgan set aside $3.05 billion for credit losses in the latest quarter; Bank of America allocated $1.5 billion; Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, more than tripling its previous reserve; and Wells Fargo committed $1.24 billion.
The increased reserves indicate that banks are preparing for a potentially riskier lending environment, where both secured and unsecured loans could lead to greater losses. A recent study by the New York Federal Reserve revealed that U.S. households owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance is climbing alongside rising delinquency rates, as consumers deplete their pandemic-era savings and increasingly depend on credit. TransUnion reported that credit card balances exceeded $1 trillion for the second consecutive quarter, highlighting the financial strain individuals are facing. The commercial real estate sector also remains vulnerable.
According to Brian Mulberry, a portfolio manager at Zacks Investment Management, the banking sector’s outlook is influenced by the aftermath of COVID-19 and the extensive stimulus measures that had been implemented to support consumers.
Experts emphasize that the provisions set aside by banks do not solely reflect recent credit quality but also their expectations about future credit conditions. Mark Narron, a senior director at Fitch Ratings, noted that the provisioning process has evolved from being reactive to a model driven by macroeconomic forecasts.
In the short term, banks are anticipating slower economic growth, a higher unemployment rate, and possible interest rate cuts later this year, which may lead to increased delinquencies and defaults.
Citigroup’s CFO Mark Mason highlighted a concerning trend among lower-income consumers, who have experienced significant declines in their savings since the pandemic. He pointed out that while the overall U.S. consumer remains resilient, there are disparities based on income levels and credit scores. Only the top income quartile has managed to save more compared to before the pandemic, while consumers with lower credit scores face rising borrowing and falling payment rates.
As the Federal Reserve maintains interest rates at a 23-year high of 5.25-5.5%, it awaits stabilization in inflation before considering any rate cuts.
Despite the proactive measures by banks in anticipation of potential defaults, experts believe that current default rates do not yet indicate a consumer crisis. Mulberry is particularly focused on the distinction between homeowners and renters from the pandemic era. He noted that many homeowners locked in low fixed mortgage rates, allowing them to weather the financial storm more effectively than renters who have faced unprecedented rent increases and rising grocery costs.
For now, analysts have observed no significant issues concerning asset quality within the banking sector. In fact, robust revenues and net interest income suggest a healthy banking landscape. Mulberry expressed cautious optimism, stating that the underlying structures of the financial system remain strong but also warned that sustained high-interest rates may lead to increased tensions in the sector moving forward.