As interest rates remain at their highest point in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks related to their lending practices.
In the second quarter, major financial institutions including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo have raised their reserves for credit losses compared to the previous quarter. These reserves are set aside to account for potential defaults on loans, including distressed debts and commercial real estate loans.
JPMorgan reported provisions for credit losses amounting to $3.05 billion, while Bank of America set aside $1.5 billion. Citigroup’s credit loss allowance reached $21.8 billion by the end of the quarter, marking a significant increase from the previous period, and Wells Fargo’s provisions stood at $1.24 billion.
The buildup in reserves suggests that banks are preparing for a potentially challenging lending environment, where both secured and unsecured loans may lead to higher losses. A recent analysis by the New York Fed indicated that American households carry a collective debt of $17.7 trillion from consumer loans, student loans, and mortgages.
Additionally, the issuance of credit cards along with rising delinquency rates has been noted, as many consumers are depleting their pandemic savings and increasingly relying on credit. Credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion, raising concerns especially in the commercial real estate market.
Brian Mulberry, a portfolio manager at Zacks Investment Management, highlighted that the financial landscape is still adjusting post-pandemic, largely influenced by the significant consumer stimulus introduced during the COVID era.
Despite these challenges, experts warn that the provisions established do not necessarily indicate current credit quality but rather reflect banks’ expectations for the future. Mark Narron from Fitch Ratings pointed out that the banking sector has shifted from a historical model where rising delinquencies would lead to increased provisions, to one where macroeconomic forecasts drive these decisions.
Looking ahead, banks are anticipating a slowdown in economic growth, a rise in unemployment, and potential interest rate cuts later in the year, which could further influence delinquency and default rates.
Citi’s CFO Mark Mason emphasized that the risks are most pronounced among lower-income consumers, who have seen their savings diminish over time.
He remarked, “While the overall U.S. consumer remains resilient, performance varies significantly across different income and credit score segments.” The highest income quartile has more savings now compared to 2019, driven by consumers with higher credit scores, while those with lower scores are facing increased financial strain due to high inflation and interest rates.
Despite preparations for wider defaults later this year, current default rates do not yet indicate a consumer crisis. Mulberry is closely monitoring the significant differences between homeowners and renters during this economic transition. Homeowners locked in low fixed-rate mortgages are less impacted by rising rates, while renters face rising living costs.
With rents increasing over 30% nationwide from 2019 to 2023 and grocery prices up 25% during the same period, renters without fixed-rate mortgages are experiencing the most significant financial stress.
Overall, the latest earnings reports reveal no significant changes in asset quality for banks, with strong revenues and net interest income suggesting a healthy banking sector. Mulberry noted that while the banking industry’s framework remains robust, prolonged high-interest rates could lead to increased stress in the future.