Amidst the current high-interest rates, which have not been seen in over two decades, and ongoing inflation that continues to affect consumers, major banks are bracing for potential challenges in their lending operations.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds set aside by banks to cover anticipated losses from credit risks, which include bad debts and troubled loans, particularly in commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America added $1.5 billion. Citigroup’s provision reached $21.8 billion, more than tripling its reserves from the previous quarter, and Wells Fargo set aside $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier financial landscape, where both secured and unsecured loans could lead to larger losses. A recent analysis from the New York Federal Reserve revealed that American households carry a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Rising credit card issuance coincides with increasing delinquency rates as many individuals exhaust their pandemic-era savings and increasingly rely on credit. Currently, credit card balances have reached $1.02 trillion, marking the second straight quarter that overall cardholder balances have exceeded the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also remains in a vulnerable position.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that we are still emerging from the COVID-19 era, emphasizing that much of the consumer financial health was bolstered by stimulus measures during the pandemic.
However, potential issues for banks may not materialize immediately. Mark Narron, a senior director at Fitch Ratings, explained that quarterly provisions do not necessarily reflect recent credit quality but are predicated on banks’ expectations for the future.
He further noted a shift in the banking system towards macroeconomic factors influencing provisioning, rather than being reactive to loan defaults.
Banks are predicting a slowdown in economic growth, higher unemployment, and two interest rate cuts later this year, likely leading to more delinquencies and defaults.
Citi’s Chief Financial Officer Mark Mason highlighted that financial distress is more pronounced among lower-income consumers who have seen their savings decline since the pandemic. He pointed out that only the top income quartile has managed to save more compared to 2019, while customers with higher credit scores are driving spending growth and maintaining payment rates.
Meanwhile, the Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation towards its 2% target before considering potential rate cuts.
Although banks are anticipating an increase in defaults in the latter part of 2023, current default rates do not yet indicate a consumer crisis, according to Mulberry. He is closely monitoring the differences between homeowners, who secured low fixed mortgage rates, and renters, who have been hit hard by rising rents.
Between 2019 and 2023, nationwide rents have surged over 30%, and grocery prices have risen 25%, stressing renters who are facing costs that are outpacing their wage growth.
Nonetheless, the latest earnings reports suggest that there are no alarming new trends in terms of asset quality. Positive indicators such as strong revenues, profits, and resilient net interest income suggest that the banking sector remains healthy.
Mulberry acknowledged a reassuring strength in the banking sector, stating that while unexpected, the current stability is a relief. However, attention remains on the potential stress that prolonged high-interest rates could induce.