As interest rates remain at their highest levels in over two decades and inflation continues to put pressure on consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, top financial institutions including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions serve as a financial cushion for potential losses from credit risks, such as delinquent debts and real estate loans.
JPMorgan set aside $3.05 billion for credit losses during the second quarter; Bank of America allocated $1.5 billion; Citigroup’s reserves reached $21.8 billion, more than tripling from the prior quarter; and Wells Fargo prepared $1.24 billion in provisions.
These increased reserves indicate that banks are preparing for a more challenging economic landscape, where both secured and unsecured loans could lead to significant losses. The New York Federal Reserve recently reported that Americans collectively owe $17.7 trillion in various consumer debts, including student loans and mortgages.
Credit card usage and delinquency rates are also climbing as consumers deplete their pandemic savings and increasingly rely on credit. As of the first quarter of this year, credit card balances exceeded $1 trillion for the second consecutive quarter, according to TransUnion. Additionally, the commercial real estate sector continues to face challenges.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted the ongoing recovery from the COVID-19 pandemic and highlighted the impact of government stimulus on consumers’ financial health.
However, banks’ current provisions may not fully reflect the recent credit quality, as they are more indicative of expectations for the future. Mark Narron, a senior director at Fitch Ratings, explained that recent banking practices have shifted towards a model where macroeconomic forecasts significantly influence provisioning, rather than solely reflecting past credit performance.
In the short term, banks anticipate slowed economic growth, increased unemployment, and potential interest rate cuts later this year, which could lead to higher delinquency and default rates.
Citigroup’s CFO Mark Mason emphasized that financial concerns primarily affect lower-income consumers, who have seen their savings diminish since the pandemic. He noted that while the overall U.S. consumer remains resilient, there is a noticeable disparity based on income and credit scores.
The Federal Reserve has kept interest rates within the range of 5.25-5.5% for 23 years, awaiting stabilization of inflation towards its 2% target before considering rate cuts.
Despite banks preparing for potential defaults in the latter part of the year, there has not yet been a pronounced increase in defaults indicative of a consumer crisis. Mulberry pointed out that homeowners who secured low fixed rates during the pandemic are less affected by rising rates, whereas renters face significant financial strain due to escalating rents.
Rent prices have surged over 30% nationwide from 2019 to 2023, while grocery costs have risen by 25% during the same period. Renters, who did not benefit from lower mortgage rates, are feeling the pinch as their rental expenses outpace wage growth.
Overall, the latest earnings reports suggest that asset quality remains stable. Strong revenues and profits indicate a robust banking sector, reassuring investors about the financial system’s resilience amidst ongoing economic challenges. Mulberry asserted that while the banking sector shows signs of health, prolonged high interest rates may increase stress in the future.