As interest rates remain at their highest levels in over two decades and inflation continues to affect consumers negatively, major banks are bracing for heightened risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions represent funds that financial institutions allocate to cover potential losses from credit risks, including defaults and delinquent debts related to lending, particularly in commercial real estate.
JPMorgan set aside $3.05 billion for credit losses during the second quarter, while 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 provision, and Wells Fargo recorded $1.24 billion in reserves.
The increased reserves highlight how banks are preparing for a riskier economic landscape, where both secured and unsecured loans may lead to greater losses. A recent report from the New York Federal Reserve noted that Americans collectively owe $17.7 trillion in various debts, including consumer loans, student loans, and mortgages.
Moreover, the rise in credit card issuance and delinquency rates reflects a growing reliance on credit as consumers deplete their pandemic-era savings. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where totals surpassed the trillion-dollar threshold, according to TransUnion. The state of commercial real estate remains uncertain as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the ongoing recovery from the COVID pandemic and the role of consumer stimulus in bolstering bank health.
However, challenges for banks are anticipated in the near future, as noted by Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group. He explained that the provisions indicated in any quarter don’t necessarily reflect current credit quality but rather banks’ expectations for future conditions.
Narron indicated that banks foresee a slowdown in economic growth, rising unemployment, and two potential interest rate cuts later this year, which could result in higher delinquency rates and defaults by year-end.
Citi’s chief financial officer, Mark Mason, highlighted concerns surrounding lower-income consumers, who have experienced significant reductions in their savings since the pandemic. He noted that while the overall U.S. consumer appears resilient, there are disparities in financial performance based on income levels and credit scores.
According to Mason, only the highest income quartile has managed to maintain higher savings compared to early 2019, and those with FICO scores over 740 are leading spending growth and keeping up with their payments. In contrast, borrowers with lower credit scores are struggling as inflation and interest rates take a toll on their financial situations.
The Federal Reserve has maintained interest rates at a high of 5.25-5.5% as it awaits a stabilization of inflation metrics toward its 2% target before considering any rate cuts.
Despite the banks preparing for possible increases in defaults in the latter half of the year, Mulberry noted that current default rates do not indicate a consumer crisis. He pointed out a distinction between homeowners and renters from the pandemic period, emphasizing that homeowners benefiting from low fixed-rate mortgages are feeling less financial strain than those who rent and have been unable to secure similar rates.
With rent prices climbing over 30% and grocery costs rising by 25% from 2019 to 2023, renters who missed out on low rates are experiencing more significant challenges in their budgets.
Looking at the recent earnings reports, Narron concluded that there were no new issues concerning asset quality. Strong revenues, profits, and resilient net interest income suggest a still-healthy banking sector. Mulberry added that while there are indications of strength in the banking industry, ongoing high interest rates may continue to exert stress in the long term.