With interest rates reaching their highest levels in over 20 years and inflation exerting pressure on consumers, major banks are bracing for increased risks related to their lending practices.
In the second quarter, top banks including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the prior quarter. These provisions are funds that financial institutions allocate to mitigate potential losses arising from credit risks such as bad debts and delinquent accounts, particularly in commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance reached $21.8 billion at the end of the quarter, more than tripling its previous reserve. Wells Fargo reported provisions amounting to $1.24 billion.
These provisions indicate that banks are preparing for a potentially more difficult lending environment, where both secured and unsecured loans may lead to greater losses. Analysis by the New York Federal Reserve shows that U.S. households owe a staggering $17.7 trillion in consumer, student, and mortgage loans.
Additionally, the demand for credit cards and the resulting delinquency rates are climbing as consumers deplete their pandemic-era savings. For instance, credit card balances hit $1.02 trillion in the first quarter, marking the second consecutive quarter where totals surpassed the trillion-dollar threshold. The commercial real estate sector continues to face challenges as well.
According to Brian Mulberry, a portfolio manager at Zacks Investment Management, the banking sector is still navigating the recovery from the COVID-19 pandemic, heavily influenced by stimulus measures that were directed at consumers.
Experts warn that any banking troubles may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, emphasized that the current provision levels do not necessarily reflect recent credit quality but rather banks’ forecasts for the future.
Banks anticipate slowing economic growth, rising unemployment, and potential interest rate cuts in September and December, which could lead to higher delinquency and default rates by the year’s end.
Republications from Citi’s CFO Mark Mason reveal that economic strain is notably affecting lower-income consumers, whose savings have diminished since the pandemic’s onset. He highlighted that only the highest income quartile has managed to retain more savings than it had in early 2019, with high-earning customers maintaining higher spending and payment rates. Conversely, customers with lower credit scores are borrowing more while experiencing substantial drops in payment rates due to inflation and high interest rates.
Despite the banks’ preparations for increased defaults, analysts like Mulberry believe that current default rates do not indicate a widespread consumer crisis. He noted the distinction between homeowners, who benefited from low fixed mortgage rates, and renters, who have seen a significant rise in rental costs.
As rental prices soared more than 30% from 2019 to 2023, along with grocery bills increasing by 25%, renters face tighter budgets compared to homeowners who secured favorable mortgage rates during the pandemic.
For the time being, analysts show optimism in the latest earnings reports, indicating no significant change in asset quality. The banking sector continues to exhibit strong revenues, profits, and net interest income, showcasing a relatively healthy financial landscape.
Analysts agree on the need to closely monitor conditions; sustained high interest rates could bring additional stress to the financial system.