With interest rates reaching levels not seen in over two decades and inflation persisting, major banks are preparing for increased risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all heightened their provisions for credit losses compared to the previous quarter. This means they are setting aside money to manage potential losses related to credit risks, such as delinquent debts and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses; Bank of America set aside $1.5 billion; Citigroup reported a total of $21.8 billion in allowance for credit losses at the end of the quarter, which more than tripled its reserve from the previous quarter; and Wells Fargo provisioned $1.24 billion.
These increased provisions indicate that banks are preparing for a risk-laden environment, where both secured and unsecured loans could lead to higher losses. Research from the New York Federal Reserve highlighted that Americans collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise as consumers deplete their savings accumulated during the pandemic and increasingly rely on credit. According to TransUnion, credit card debt reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances surpassed $1 trillion. Commercial real estate also remains in a vulnerable position.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, pointed out, “We’re still coming out of this COVID era, particularly regarding banking and consumer health, largely due to the stimulus provided to consumers.”
However, the true challenges for banks are anticipated in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that quarterly provisions reflect banks’ expectations for future credit quality, rather than just recent trends.
Banks foresee slower economic growth, higher unemployment, and potential interest rate cuts in September and December, which could result in increased delinquencies and defaults as the year concludes.
Citi’s CFO Mark Mason noted that warning signs seem concentrated among lower-income consumers whose savings have diminished since the pandemic. He emphasized the disparity in financial performance: only the highest-income quartile has more savings than before 2019, while those in lower FICO bands are experiencing greater financial strain and borrowing more due to inflation and rising interest rates.
The Federal Reserve has retained interest rates at a peak of 5.25-5.5%, waiting for inflation to stabilize toward its 2% target before implementing anticipated rate cuts.
Despite banks bracing for potential defaults, current default rates do not indicate an impending consumer crisis, according to Mulberry. He is particularly monitoring the differences between homeowners and renters during this period. Homeowners benefit from low fixed rates locked in previously, while renters face escalating costs.
Rent prices have surged over 30% nationwide from 2019 to 2023, with grocery costs rising 25% during the same timeframe. Renters, lacking the advantage of fixed rates, are feeling the most financial pressure in their budgets.
For now, the latest earnings reports suggest stability in asset quality. Strong revenues and net interest income point to a robust banking sector. Mulberry noted, “While there are some positive signs in the banking sector, the strain will increase the longer high interest rates persist.”