With interest rates at their highest level in over 20 years and inflation affecting consumers, major banks are bracing for increased risks in 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 represent the funds set aside by financial institutions to cover potential losses from credit risk, such as delinquent loans and bad debts, particularly in sectors like commercial real estate loans.
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 rose to $21.8 billion, more than tripling its reserve from the prior quarter, and Wells Fargo reported provisions of $1.24 billion.
This increase signals that banks are preparing for a challenging environment, where both secured and unsecured loans could lead to larger losses. A recent analysis by the New York Federal Reserve highlighted that Americans now owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Furthermore, the issuance of credit cards and delinquency rates are also climbing, as many individuals exhaust their pandemic-era savings and increasingly rely on credit. By the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter where total cardholder balances surpassed one trillion dollars, according to TransUnion. The commercial real estate sector also remains vulnerable.
Experts note that the banking sector is still recovering from the effects of the COVID-19 pandemic. Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked that the consumer health was largely supported by stimulus measures introduced during the pandemic.
However, challenges for banks are expected to emerge in the upcoming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions do not reflect the quality of credit from the past three months but instead indicate banks’ forecasts for future trends.
He noted a significant shift from the traditional practice where rising loan defaults prompted increased provisions, to a scenario where macroeconomic forecasts drive provisioning strategies.
In the short term, banks anticipate slowing economic growth, increased unemployment rates, and two possible interest rate cuts later this year, likely in September and December. This could lead to more delinquencies and defaults as the year comes to a close.
Citigroup’s chief financial officer, Mark Mason, highlighted concerning trends among lower-income consumers, who have seen a decline in savings since the pandemic’s onset. He emphasized that while the overall U.S. consumer remains resilient, the performance varies significantly across different income groups and credit scores. Only those in the highest income bracket have maintained their savings, while individuals with lower credit scores are experiencing decreasing payment rates and increasing borrowing.
Despite these concerns, the Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it seeks stability in inflation measures toward its 2% target before implementing anticipated rate cuts.
Currently, while banks are preparing for potential defaults in the latter half of the year, the rates are not escalating to a level that signals a consumer crisis, according to Mulberry. He pointed out the significant differences between homeowners and renters, noting that homeowners who secured low fixed-rate mortgages are not feeling the immediate financial strain compared to renters facing soaring rental costs.
Data shows rents have risen by over 30% nationwide from 2019 to 2023, with grocery prices also increasing by 25%, leading to heightened financial pressures for renters who have not had the benefit of locking in low rates.
For now, analysts report that the latest earnings indicate stability in asset quality. With strong revenues and profits, as well as robust net interest income, the banking sector remains in good health.
Mulberry concluded that while the banking sector shows some underlying strength, ongoing high interest rates would continue to exert pressure over time.