As interest rates remain at their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for increased risks associated with their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all elevated their provisions for credit losses compared to the previous quarter. These provisions are set aside to cover potential losses from credit risks, including bad debts and commercial real estate loans.
Specifically, JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, more than tripling from the prior period. Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier lending environment, where both secured and unsecured loans may lead to larger losses. A recent analysis by the New York Fed revealed that Americans collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Moreover, credit card issuance and delinquency rates are on the rise as individuals deplete their pandemic-era savings and increasingly rely on credit. As of the first quarter of this year, credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. Additionally, the commercial real estate sector is facing its own set of challenges.
Brian Mulberry, client portfolio manager at Zacks Investment Management, noted that the ongoing recovery from the pandemic and the availability of consumer stimulus have played significant roles in the current banking landscape.
However, banks anticipate challenges in the months ahead. Mark Narron, a senior director at Fitch Ratings, explained that current provisions do not necessarily reflect the immediate credit quality but rather banks’ expectations for future credit conditions.
He highlighted a shift from a historical framework, where provisions increased in response to bad loans, to a model driven more by macroeconomic forecasts.
Looking forward, banks expect slowing economic growth, a rising unemployment rate, and potential interest rate cuts later in the year, which could lead to increased delinquencies and defaults.
Citi’s CFO Mark Mason pointed out that these warning signs are particularly evident among lower-income consumers, who have seen their savings diminish since the pandemic began.
He emphasized a divergence in financial behavior, stating that only the highest-income quartile has more savings now compared to early 2019. Customers with higher credit scores are responsible for spending growth and high payment rates, while those with lower scores are experiencing sharper declines in payment rates and are borrowing more due to high inflation and interest rates.
As the Federal Reserve maintains interest rates at a 23-year high of 5.25-5.5%, it awaits stabilization in inflation toward its target of 2% before considering rate cuts.
Despite the banks’ preparations for potential defaults later this year, Mulberry noted that defaults are not yet escalating at a rate that signals a consumer crisis. He is particularly focused on the distinction between homeowners and renters during the pandemic.
He explained that while rates have increased significantly, homeowners locked in low fixed rates on their loans and are not feeling as much financial strain. In contrast, renters, who did not secure such opportunities, are facing significant pressure from rising rental costs and inflation.
Currently, the key takeaway from the latest earnings reports is that there has been no significant deterioration in asset quality. There are signs of robust revenues, profits, and strong net interest income, indicating a resilient banking sector.
Mulberry remarked on the strength and stability of the financial system, but cautioned that prolonged high interest rates could lead to more stress in the future.