With interest rates reaching their highest levels in over 20 years and inflation still affecting consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions are set aside by financial institutions to cover potential losses from credit risks, including delinquent accounts and bad debt, particularly in areas like commercial real estate loans.
JPMorgan allocated $3.05 billion for credit loss provisions 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 its reserve buildup from the prior quarter. Wells Fargo also increased its provisions, totaling $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans could lead to greater losses. An analysis by the New York Fed highlighted that American households owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, the issuance of credit cards and delinquency rates are both rising as individuals deplete their pandemic-era savings and increasingly depend on credit. Credit card balances exceeded $1 trillion in the first quarter, marking the second consecutive quarter this figure has surpassed that milestone, according to TransUnion. The commercial real estate sector also remains in a fragile state.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that banks are still navigating the aftermath of the COVID-19 pandemic, which was significantly influenced by government stimulus for consumers.
Experts indicate that any forthcoming issues for banks may manifest in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported each quarter do not solely reflect recent credit quality; rather, they indicate banks’ expectations of future conditions.
Banks are forecasting slower economic growth, a rise in unemployment, and potential interest rate cuts in September and December, which could lead to more delinquencies and defaults by year’s end.
Citi’s chief financial officer, Mark Mason, pointed out that signs of distress are primarily evident among lower-income consumers who have seen their savings diminish since the pandemic.
“Although we see a generally resilient U.S. consumer, performance varies significantly across different income levels,” Mason stated in a recent analyst call. He added that only the highest income consumers have more savings now compared to early 2019, with those in the lower income brackets experiencing sharper declines in payment rates and borrowing more due to the effects of high inflation and interest rates.
The Federal Reserve is maintaining interest rates at a 23-year high of 5.25% to 5.5%, awaiting stabilization in inflation metrics before considering the anticipated rate cuts.
Despite banks gearing up for increased defaults later in the year, experts believe that current default rates do not signify an imminent consumer crisis. Mulberry suggests that the impact may differ between homeowners and renters, given that homeowners secured low fixed rates during the pandemic, while renters did not.
Rent prices have surged by over 30% nationwide from 2019 to 2023, coupled with a 25% rise in grocery expenses during the same timeframe. This has placed significant pressure on renters, who face escalating rental costs that exceed wage growth.
At present, analysts note that the latest earnings reports show stability in asset quality. There is evidence of strong revenues, profits, and resilient net interest income, which are positive signs for the banking sector.
Mulberry expressed relief over the robustness of the financial system: “While some strength in the banking sector was expected, it’s reassuring to see that the structural integrity remains strong. However, we continue to monitor the potential stress from prolonged high interest rates.”