As interest rates remain at their highest levels in over two decades, and inflation continues to impact consumers, major banks are gearing up for potential risks tied to their lending operations.
In the second quarter, several large banks—JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo—increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside to cover possible losses from credit risk, including bad debts and lending, particularly in commercial real estate.
JPMorgan set aside $3.05 billion for credit losses during the second quarter; Bank of America allocated $1.5 billion; Citigroup’s credit loss allowance reached $21.8 billion, more than tripling its reserve from the prior quarter; while Wells Fargo contributed $1.24 billion.
The increase in reserves suggests that banks are anticipating a riskier lending landscape, where both secured and unsecured loans may lead to greater losses. A recent analysis by the New York Federal Reserve indicated that U.S. households owe a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, credit card issuance is on the rise, with delinquency rates increasing as consumers deplete their pandemic savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where this total exceeded a trillion dollars, as reported by TransUnion. The commercial real estate sector continues to face uncertainty.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the economy is still emerging from the COVID-19 period, heavily influenced by the stimulus measures that were in place for consumers.
Challenges for banks are expected to surface in the coming months. Mark Narron, a senior director at Fitch Ratings, emphasized that current provisions reflect banks’ expectations for future credit quality rather than recent trends.
He pointed out that the economic outlook is forcing banks to adjust their provisioning strategies, moving from a historic system based on past loan performance to one that relies on broader economic forecasts.
As banks foresee slower economic growth, rising unemployment, and potential interest rate cuts later in the year, analysts predict an increase in delinquencies and defaults.
Citi’s CFO Mark Mason highlighted that the financial strain appears to be concentrated among lower-income consumers, who have seen their savings diminish since the pandemic began. He noted a marked distinction in consumer behavior based on credit scores and income levels, with only the highest earners maintaining savings from pre-pandemic levels.
The Federal Reserve currently maintains interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation before considering rate reductions.
Despite the banks’ preparations for a potential rise in defaults later this year, current rates of default do not indicate a consumer crisis, according to Mulberry. He pointed out that homeowners, who locked in low fixed rates during the pandemic, currently face less financial strain than renters, who are grappling with rising rental costs without similar protections.
Overall, the latest earnings reports reflect that there were no surprising developments in asset quality this quarter. Strong revenues, profits, and consistent net interest income indicate that the banking sector remains robust.
Mulberry concluded that, despite some stress due to persistently high interest rates, the overall structure of the financial system is solid, yet continued monitoring is essential.