With interest rates reaching their highest levels in over two decades and persistent inflation affecting consumers, major banks are bracing for increased risks associated with their lending activities.
In the second quarter, leading financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks reserve to mitigate potential losses from credit risks, which can arise from delinquent debts and various loans, including commercial real estate (CRE) loans.
JPMorgan reported a provision for credit losses of $3.05 billion in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s credit loss allowance rose to $21.8 billion by the end of the quarter, more than tripling its reserves from the previous period. Wells Fargo recorded provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a tougher financial landscape, where defaults on both secured and unsecured loans could lead to larger losses. A recent analysis by the New York Fed revealed that American households collectively owe $17.7 trillion on various loans, including consumer credit, student loans, and mortgages.
Furthermore, the rate of credit card issuance and related delinquency is escalating as consumers deplete their pandemic savings and increasingly depend on credit. According to TransUnion, total credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where cardholder balances surpassed the trillion-dollar threshold. The commercial real estate sector also remains vulnerable.
Experts attribute these trends to the lingering effects of the COVID era, particularly the financial support provided to consumers during that time, as noted by Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any challenges for banks will likely manifest in the coming months. Mark Narron, a senior director at Fitch Ratings, stated that current provisions do not necessarily reflect the recent credit quality but instead predict future trends. This shift in approach contrasts with historical norms, where rising loan defaults triggered increased provisions.
Looking ahead, banks anticipate slower economic growth, higher unemployment rates, and potential interest rate cuts later this year. Such developments could result in more delinquent accounts and defaults as the year concludes.
Citigroup’s CFO Mark Mason pointed out that the warning signs are particularly evident among lower-income consumers, who have experienced significant depletion of their savings in the aftermath of the pandemic. He remarked that while the overall U.S. consumer remains resilient, a clear divergence in financial stability exists based on income and credit scores.
Currently, only consumers in the highest income bracket have managed to retain more savings than they had in 2019, whereas those with lower credit scores are facing declining payment rates and increasing borrowing, primarily due to high inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% while waiting for inflation indicators to stabilize around the central bank’s 2% target, which could set the stage for anticipated rate cuts.
Despite the banks’ preparations for possible defaults, Mulberry noted that current default rates do not signal an impending consumer crisis. He emphasized the distinction between homeowners and renters during the pandemic, highlighting that homeowners locked in low fixed rates and are less affected by rising costs compared to renters.
With rents increasing by over 30% nationally from 2019 to 2023 and grocery prices rising by 25% during the same timeframe, renters who did not secure favorable rates are facing greater financial pressures.
For now, key takeaways from the latest earnings reports indicate stability in asset quality. Experts report that strong revenues, profits, and consistent net interest income suggest a robust banking sector. Mulberry expressed cautious optimism about the resilience of the financial system but warned that prolonged high interest rates could lead to increased strain on the sector.