Amid rising interest rates, which are currently at the highest levels in over 20 years, and ongoing inflation challenges, major banks are bracing for potential risks in their lending practices.
In their recent quarterly reports, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their credit loss provisions compared to the previous quarter. These provisions represent funds set aside by banks to cover expected losses from credit risks, including delinquent loans and bad debts, particularly commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses rose to $21.8 billion, a significant jump from the prior quarter, and Wells Fargo reported provisions of $1.24 billion.
These reserve increases indicate that banks are bracing themselves for a more challenging lending environment, where they anticipate greater losses from both secured and unsecured loans. The New York Federal Reserve recently reported that American households collectively owe $17.7 trillion across various forms of consumer debt, including student loans and mortgages.
Credit card usage is also rising, with delinquency rates climbing as Americans rely more heavily on credit following the depletion of pandemic-era savings. Credit card debt reached $1.02 trillion in the first quarter, marking the second consecutive quarter where balances exceeded a trillion dollars, according to TransUnion. The commercial real estate sector is also facing significant uncertainties.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that while the banking sector is navigating through the aftermath of the COVID era, the health of consumers has been heavily influenced by substantial government stimulus.
Analysts warn that any banking challenges may only surface later. Mark Narron from Fitch Ratings indicated that the provisions banks report are based on future expectations rather than reflecting past credit quality. He mentioned a shift in how banks are provisioning, moving from a reactionary model based on bad loans to one driven by macroeconomic forecasts.
In the short term, banks expect decelerated economic growth, a rise in unemployment, and potentially two interest rate cuts anticipated for September and December, which could lead to more delinquencies and defaults as the year progresses.
Citigroup’s CFO Mark Mason highlighted concerning trends among lower-income consumers, who have experienced dwindling savings since the pandemic. He pointed out that only the highest income quartile has managed to save more than they had at the beginning of 2019. Customers with credit scores above 740 are primarily responsible for spending growth, while those in lower score brackets are increasingly struggling to keep up with high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year pinnacle of 5.25% to 5.5%, waiting for inflation to stabilize toward its 2% target before considering rate cuts.
Despite the banks’ preparations for increased defaults, signs do not yet indicate a consumer crisis, according to Mulberry. He is monitoring the difference between homeowners from the pandemic era and renters, noting that homeowners are largely shielded from immediate financial strain due to locked-in low fixed rates.
With rent skyrocketing over 30% nationwide between 2019 and 2023 and grocery prices climbing 25%, renters are experiencing the most financial pressure without the benefits of fixed-rate mortgages, according to Mulberry.
Overall, the latest earnings reports indicate stability in asset quality, with strong revenues, profits, and net interest income suggesting a resilient banking sector. Experts express confidence in the longer-term stability of the financial system, though they maintain vigilance regarding the potential stress caused by persistently high interest rates.