With interest rates hitting levels not seen in over two decades and inflation putting pressure on consumers, major banks are bracing for heightened risks in their lending practices.
During the second quarter, prominent banks including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside to cover potential losses due to credit risks such as bad debt and delinquent loans, particularly in sectors like commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit loss provisions during the second quarter, 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 more than the previous quarter’s provisions, and Wells Fargo provided $1.24 billion.
These increased provisions reflect the banks’ anticipation of a riskier lending environment where both secured and unsecured loans could lead to larger losses. A recent report from the New York Federal Reserve revealed that Americans owe a total of $17.7 trillion in consumer loans, student debt, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as consumers deplete their savings accrued during the pandemic and increasingly depend on credit. According to TransUnion, credit card balances surged to $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar mark. The CRE sector also remains vulnerable.
Brian Mulberry, a portfolio manager at Zacks Investment Management, remarked that the lingering impacts of the COVID-19 pandemic, particularly regarding banking and consumer health, have been influenced by the stimulus efforts aimed at protecting consumers.
Experts suggest that any challenges for banks may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that current provisions do not simply reflect recent credit quality but rather forecast expected future conditions.
In the short term, banks are predicting a slowdown in economic growth, an uptick in unemployment, and potential interest rate cuts later this year. This could lead to an increase in delinquencies and defaults as the year closes.
Citigroup CFO Mark Mason highlighted that emerging issues are primarily affecting lower-income consumers who have experienced diminishing savings since the pandemic.
He pointed out that while the overall U.S. consumer remains resilient, there is a marked discrepancy in financial performance across different income levels and credit scores. Only the highest income quartile has more savings now compared to early 2019, while consumers with lower credit scores are struggling more with payment rates as they grapple with high inflation and rising interest rates.
With the Federal Reserve maintaining interest rates at a 23-year high of 5.25% to 5.5%, it awaits stabilization in inflation towards its 2% target before considering rate reductions.
Despite preparing for potential increases in defaults, current default rates are not indicative of a consumer crisis. Mulberry is paying special attention to the differences between homeowners and renters from the pandemic period.
Though interest rates have increased significantly, homeowners benefitting from low fixed rates are not experiencing the same financial strain as renters, who have seen rent prices soar by over 30% from 2019 to 2023, alongside a 25% increase in grocery costs.
So far, the latest earnings reports indicate stability in asset quality, with strong revenues, profits, and resilient net interest income serving as positive signs for the banking sector.
Mulberry expressed optimism about the robustness of the financial system, emphasizing that while there are positive indicators, the longer high interest rates persist, the more pressure they may create.