As interest rates remain at their highest in over 20 years and inflation continues to impact consumers, major banks are bracing for heightened risks in their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. This provision refers to the funds set aside by financial institutions to cover potential losses from credit risks, which include delinquent accounts and problematic lending, especially in commercial real estate (CRE).
JPMorgan allocated $3.05 billion towards credit loss provisions in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s total allowance for credit losses reached $21.8 billion at the end of the quarter, significantly higher than its previous reserves, while Wells Fargo recorded provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a more tumultuous lending environment, predisposed to creating larger losses for major financial institutions. According to recent analysis from the New York Federal Reserve, total household debt in the U.S. amounts to approximately $17.7 trillion, spread across various consumer loans, student loans, and mortgages.
Furthermore, credit card issuance and delinquency rates are climbing as consumers exhaust their pandemic savings and increasingly rely on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter where they surpassed the trillion-dollar mark, according to TransUnion. The CRE sector also faces ongoing challenges.
Experts note that the banking sector’s current health is partly a result of government stimulus during the COVID-19 pandemic. However, potential challenges for banks are anticipated in the coming months.
Mark Narron, a senior director with Fitch Ratings, explained that the provisions reported by banks do not solely reflect historical credit quality but are also based on future expectations. He highlighted that banks have shifted to relying on macroeconomic forecasts to inform their credit loss provisions rather than adjusting provisions reactively based on bad loans.
In the near future, banks are expecting slower economic growth, an increase in unemployment, and two anticipated interest rate cuts in September and December, leading to concerns over possible delinquencies and defaults by year-end.
Citigroup’s chief financial officer, Mark Mason, pointed out that the economic pressures are particularly evident among lower-income consumers, who have seen their savings diminish since the pandemic. He observed a divide in consumer behavior, indicating that only the highest-income households have managed to increase their savings since 2019, while those with lower credit scores exhibit sharp declines in payment rates and have been borrowing more due to the strain of inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 5.25-5.5% range for 23 years, awaiting stabilization in inflation rates before making anticipated cuts.
Despite the banks’ preparations for increased defaults in the latter part of the year, there has not yet been a significant rise in default rates indicating a consumer crisis. Observers are particularly attentive to the discrepancy between homeowners and renters from the pandemic era.
While interest rates have surged, homeowners who secured low fixed rates on their debts are less affected compared to renters, who have experienced rent increases exceeding wage growth, facing more budgetary pressure, especially as rents have risen over 30% nationally since 2019.
Currently, the latest earnings reports indicate stability in the banking sector, with no new issues related to asset quality emerging. Positive revenue, profit, and net interest income figures reflect a robust banking environment. Experts emphasize that while the banking sector appears strong, continued high interest rates could induce further stress over time.