As interest rates hit their highest levels in over 20 years, and inflation continues to pressure consumers, major banks are closely monitoring the risks associated with their lending practices.
In the second quarter of this year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions are essential as they allow banks to set aside funds to cover potential losses from credit risks, including defaults on loans and bad debts, particularly in the commercial real estate sector.
JPMorgan allocated $3.05 billion for credit losses, while Bank of America set aside $1.5 billion. Citigroup reported a total allowance for credit losses of $21.8 billion, a significant increase from the prior quarter, and Wells Fargo provided $1.24 billion.
These increased provisions suggest banks are preparing for a more challenging lending environment, where both secured and unsecured loans pose greater risks. An analysis by the New York Federal Reserve indicated that Americans’ collective debt has reached $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
Moreover, the rise in credit card issuance and subsequent delinquency rates points to consumers depleting their pandemic-era savings and increasingly relying on credit. For instance, credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. The commercial real estate sector also remains in a vulnerable state.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, emphasized the lingering aftereffects of the COVID pandemic on banking and consumer health. He noted that the stimulus measures implemented during that time have influenced current credit behaviors.
However, experts warn that any complications for banks may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions set by banks reflect expectations for future credit quality rather than recent performance.
Currently, banks anticipate a slowdown in economic growth, an increase in unemployment, and potential interest rate cuts later this year, which could lead to higher rates of delinquencies and defaults as 2023 closes.
Citi’s CFO Mark Mason highlighted that the concerns are particularly pronounced among lower-income consumers, who have experienced significant declines in their savings since the pandemic began. He noted that only consumers in the highest income bracket have managed to maintain their savings levels since 2019, while those in lower FICO score ranges are struggling more with rising costs and heightened borrowing.
The Federal Reserve has maintained its interest rates at a 23-year high of 5.25-5.5% as it monitors inflation trends, aiming to stabilize rates before making cuts.
Despite projecting increased defaults, Mulberry stated that current default rates do not indicate a looming consumer crisis. He observed the distinction between homeowners and renters during the pandemic, noting that many homeowners benefited from securing low fixed rates, while renters have faced escalating rental costs.
With national rent prices surging over 30% and grocery costs increasing by 25% from 2019 to 2023, renters who did not lock in lower rates are experiencing significant financial strain.
Ultimately, recent earnings demonstrate that the banking sector remains robust, with strong revenues and profits. Narron stated there were no significant changes in asset quality this quarter, providing some assurance that the financial system remains sound. However, the ongoing high-interest rates could introduce more challenges in the future.