As interest rates hit over two-decade highs and inflation continues to squeeze consumers, major banks are bracing for potential risks in their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their provisions for credit losses compared to the previous quarter. These provisions are funds set aside by financial institutions to cover potential losses such as delinquent debts or bad loans, including those related to commercial real estate.
JPMorgan set aside $3.05 billion for credit losses in the second quarter; Bank of America allocated $1.5 billion; Citigroup’s allowance for credit losses reached $21.8 billion, more than tripling its reserves from the previous quarter; while Wells Fargo noted provisions of $1.24 billion.
The increase in provisions indicates that banks are preparing for a more challenging economic environment where both secured and unsecured loans may lead to greater losses. A recent analysis from the New York Federal Reserve revealed that American households owe a staggering $17.7 trillion in various debts, including consumer loans, student loans, and mortgages.
Moreover, credit card usage and delinquency rates are rising as consumers deplete their savings from the pandemic and rely more on credit. Credit card balances exceeded $1.02 trillion in the first quarter of this year, marking the second consecutive quarter above the trillion-dollar threshold, according to TransUnion. Commercial real estate also remains in a vulnerable position.
According to Brian Mulberry, a portfolio manager at Zacks Investment Management, the financial strain on banks is expected to escalate in the coming months, stemming from the economic uncertainties triggered by the COVID-19 era and subsequent stimulus measures.
Mark Narron, a senior director at Fitch Ratings, explained that provisions reported by banks do not necessarily reflect recent credit quality but rather what banks anticipate in the future. As economic growth slows and unemployment rises, banks are likely to see an increase in delinquencies and defaults as the year progresses.
Citi’s chief financial officer, Mark Mason, highlighted emerging risks concentrated among lower-income consumers, who have seen their savings decline post-pandemic. While the overall U.S. consumer remains resilient, there is a divergence in economic performance across different income levels, with only the highest income quartile maintaining increased savings since early 2019.
The Federal Reserve’s interest rates remain at a 23-year high of 5.25-5.5% as it awaits stabilization in inflation towards a 2% target before potentially implementing rate cuts.
Currently, while banks are expecting an increase in defaults, overall default rates have not reached a level indicative of a consumer crisis, according to Mulberry. He noted the differing experiences between homeowners, who locked in low fixed rates during the pandemic, and renters facing significantly increasing rents.
Data shows that rents have surged over 30% nationwide from 2019 to 2023, while grocery costs have risen by 25%, pushing renters without fixed low rates into tighter financial situations.
Despite potential challenges, the latest earnings reports indicate that asset quality remains stable, with robust revenues, profits, and net interest income reflecting a healthy banking sector. Mulberry concluded that while the financial system’s structure remains strong, ongoing high-interest rates could lead to increased stress in the future.