As interest rates hold at more than two-decade highs and inflation continues to affect consumers, major banks are preparing for increased risks associated with their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all boosted their provisions for credit losses compared to the previous quarter. These provisions represent the funds set aside by financial institutions to cover potential losses from credit risks, including delinquent or bad debts and commercial real estate loans.
JPMorgan allocated $3.05 billion to its provision 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 at the end of the quarter, more than tripling its previous reserve build. Wells Fargo’s provisions totaled $1.24 billion.
The increased provisions indicate that banks are preparing for a riskier lending environment, where both secured and unsecured loans could result in more significant losses. A recent analysis by the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
As pandemic-era savings diminish, credit card issuance and delinquency rates are also on the rise. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total balances surpassed the trillion-dollar threshold. The commercial real estate sector remains in a vulnerable position.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the ongoing effects of COVID-19 on banking and consumer health can be traced back to the stimulus deployed during the pandemic.
Challenges for banks are expected to emerge in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, stated that the provisions reported each quarter do not directly reflect the credit quality for the past three months, but rather the banks’ expectations for the future. He noted a shift in provisioning methodology, where macroeconomic forecasts now significantly drive these decisions.
Near-term predictions suggest slowing economic growth, a rising unemployment rate, and two anticipated interest rate cuts later this year in September and December, which could lead to increased delinquencies and defaults.
Citi’s chief financial officer, Mark Mason, highlighted that concerns appear to be concentrated among lower-income consumers, who have seen their savings diminish since the pandemic. He pointed out that only the highest income quartile has more savings than in early 2019, while those with lower credit scores are experiencing a sharper decline in payment rates and are borrowing more due to the impacts of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it awaits stabilization of inflation towards the central bank’s 2% target before implementing the anticipated rate cuts.
Despite banks bracing for potential defaults in the latter half of the year, defaults have not yet risen at a rate suggesting a consumer crisis. Mulberry noted that homeowners who secured low fixed-rate mortgages during the pandemic are generally not feeling the financial strain, unlike renters who could not take advantage of these rates.
With rent increasing over 30% nationwide from 2019 to 2023 and grocery prices rising by 25% in that period, renters have been particularly hard hit as they face rental costs that have outpaced wage growth.
Overall, the latest earnings reports indicate that there are no significant new issues regarding asset quality. Strong revenues, profits, and resilient net interest income suggest a currently stable banking sector. Mulberry stated, “The strength of the financial system remains robust. However, sustained high interest rates could lead to increased stress.”