As interest rates remain at their highest levels in over 20 years and inflation continues to impact consumers, major banks are preparing for increased risks associated with their lending practices.
In the second quarter, large financial institutions including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all raised their provisions for credit losses compared to the previous quarter. These provisions are funds set aside by banks to cover potential losses from credit risks, such as delinquent loans and bad debt, including commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, significantly increasing from its previous reserve. Wells Fargo reported $1.24 billion in provisions.
These increased provisions indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans could lead to greater losses. A recent report from the New York Federal Reserve revealed that total U.S. household debt has risen to $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
Additionally, credit card issuance is up, along with delinquency rates, as consumers tap into credit due to depleted savings accumulated during the pandemic. In the first quarter, total credit card balances exceeded $1 trillion for the second consecutive quarter, as noted by TransUnion. Commercial real estate continues to face challenges as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked that banks are still recovering from the pandemic era, citing how consumer stimulus had previously bolstered the economy.
However, analysts warn that banks may face more issues in the coming months. Mark Narron from Fitch Ratings explained that the current quarterly provisions do not solely reflect recent credit quality but rather banks’ expectations for future challenges.
Banks are anticipating slower economic growth, rising unemployment, and potential interest rate cuts later this year, which could lead to an increase in delinquencies and defaults.
Citi’s Chief Financial Officer Mark Mason highlighted a concerning trend among lower-income consumers, whose financial situations have worsened since the pandemic. He noted that only the highest income quartile has seen an increase in savings since early 2019. Customers with high credit scores are driving spending growth and maintaining high payment rates, while those with lower scores are struggling more and increasing their borrowing as they are affected by rising inflation and interest rates.
The Federal Reserve has maintained interest rates between 5.25% and 5.5% for 23 years, waiting for inflation to stabilize towards its 2% target before implementing any anticipated rate cuts.
Despite preparing for an increase in defaults later in the year, experts indicate that current default rates do not signal a consumer crisis. Mulberry pointed out that homeowners who secured low fixed rates during the pandemic are not feeling the financial strain, unlike renters facing soaring costs.
Between 2019 and 2023, rents rose over 30% and grocery costs increased by 25%, putting extra pressure on renters’ budgets who couldn’t lock in favorable rates.
Overall, the latest earnings reports suggest stability in asset quality. Positive trends in revenues, profits, and net interest income indicate a still-healthy banking sector. Mulberry expressed relief over the strength of the financial system, though he cautioned that sustained high interest rates could lead to future stress.