With interest rates at their highest in over two decades and inflation continuing to pressure consumers, major banks are preparing 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 are reserves set aside by financial institutions to cover potential losses from credit risks, including unpaid debts and loans such as commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses during the second quarter; Bank of America reported $1.5 billion; Citi’s allowance rose to $21.8 billion, significantly increasing from the prior quarter; and Wells Fargo set aside $1.24 billion.
These provisions indicate that banks are preparing for a riskier environment, where both secured and unsecured loans could lead to greater losses. Recent analysis from the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, both credit card issuance and delinquency rates are on the rise as individuals rely more on credit after depleting their pandemic-era savings. In the first quarter, credit card balances reached $1.02 trillion, marking the second straight quarter where total balances surpassed $1 trillion. The commercial real estate market also remains under pressure.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the current banking environment is still recovering from the effects of COVID-19, largely influenced by the stimulus provided to consumers during that time.
However, banks are anticipating challenges ahead. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that current provisions do not reflect recent credit quality, but rather banks’ expectations for future conditions. He highlighted the shift from a historical pattern where provisions increased in response to rising loan defaults, to a scenario where macroeconomic forecasts are driving provisioning choices.
In the short term, banks are warning of slower economic growth, a higher unemployment rate, and the likelihood of interest rate cuts later this year, which could result in more delinquencies and defaults as 2023 comes to a close.
Citi’s chief financial officer, Mark Mason, pointed out that financial difficulties appear to be particularly affecting lower-income consumers, who have seen their savings diminish in the aftermath of the pandemic. He noted that among their consumer clients, only those in the highest income quartile have managed to increase their savings since early 2019, while those with lower credit scores are facing greater declines in payment rates and are borrowing more due to the pressures of inflation and rising interest rates.
The Federal Reserve is maintaining interest rates at a 23-year high of 5.25-5.5% as it waits for inflation to stabilize before implementing anticipated rate cuts.
Despite the banks preparing for possibly higher defaults later this year, Mulberry maintains that current default rates do not indicate a consumer crisis. He is particularly monitoring the differences between homeowners and renters during this period. Homeowners, who secured low fixed rates on their mortgages, are less affected by rising rates compared to renters who have faced significant rental price increases.
As rents have surged over 30% nationwide from 2019 to 2023 and grocery costs have increased by 25%, renters without the security of fixed-rate mortgages are experiencing heightened financial strain.
At this stage, the latest earnings reports show no significant deterioration in asset quality, and banks continue to demonstrate strong revenues, profits, and net interest income, suggesting a resilient banking sector. Mulberry expressed relief that the financial system remains robust but cautioned that prolonged high interest rates could lead to increased stress in the future.