With interest rates currently at their highest levels in over 20 years and inflation affecting consumers, major banks are bracing for potential risks associated with their lending practices.
In the second quarter of the year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions refer to the funds that banks allocate to cover potential losses from credit risks, including bad debt and delinquent loans, such as those in commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America added $1.5 billion. Citigroup reported a total of $21.8 billion in credit loss allowances at the end of the quarter, significantly tripling its reserves from the previous quarter. Wells Fargo, too, increased its provisions to $1.24 billion.
These heightened provisions indicate that banks are preparing for a riskier financial landscape, where both secured and unsecured loans may lead to greater losses. A recent analysis by the New York Federal Reserve revealed that Americans collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are on the rise, as people deplete their pandemic-era savings and increasingly depend on credit. In the first quarter, credit card balances reached $1.02 trillion, marking the second consecutive quarter where total cardholder balances exceeded this milestone, according to TransUnion. Additionally, the CRE sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked on the lingering effects of the COVID era on banking and consumer health, highlighting the role of government stimulus during that time.
Analysts suggest that significant problems for banks may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that quarterly provisions do not directly reflect credit quality but rather banks’ expectations for future economic conditions.
In the short term, banks anticipate slowing economic growth, increased unemployment rates, and potential interest rate cuts in September and December of this year. These changes may lead to more delinquencies and defaults as the year comes to a close.
Citigroup’s CFO, Mark Mason, pointed out that risks appear concentrated among lower-income consumers whose savings have diminished since the pandemic. While the overall U.S. consumer remains resilient, there is noticeable divergence in performance based on credit scores and income levels.
According to Mason, the highest income quartile has managed to save more compared to the beginning of 2019, driven by customers with higher credit scores. Conversely, customers with lower credit scores are experiencing declines in payment rates and are borrowing more due to significant inflationary pressures.
The Federal Reserve continues to hold interest rates at a range of 5.25-5.5%, the highest in 23 years, while monitoring inflation trends toward its 2% target before implementing any rate cuts.
Despite banks preparing for increased defaults later this year, Mulberry noted that current default rates do not indicate a consumer crisis. He is closely observing the distinction between homeowners who locked in low fixed mortgage rates and renters who face rising costs.
With rent prices increasing over 30% nationwide from 2019 to 2023 and grocery costs climbing 25% in the same timeframe, renters who missed the chance to secure lower rates are experiencing greater financial stress, according to Mulberry.
Overall, the latest earnings reports indicate no new concerns regarding asset quality, with strong revenues and robust net interest income being positive signs of a healthy banking sector. Mulberry expressed relief that the financial system remains strong, though he cautioned that sustained high interest rates could contribute to increased stress over time.