As interest rates remain at their highest levels in over two decades and inflation persists, major banks are preparing for increased risks associated with 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 funds set aside by financial institutions to cover potential losses from credit risks such as delinquent debts and commercial real estate loans.
Specifically, JPMorgan allocated $3.05 billion for credit losses, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, significantly up from the previous estimates. Wells Fargo’s provisions amounted to $1.24 billion.
These increases indicate that banks are bracing for a more challenging environment where both secured and unsecured loans could lead to higher losses. A recent New York Fed analysis revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, the rate of credit card issuance and delinquency is rising as consumers exhaust their savings accrued during the pandemic and turn to credit more frequently. Credit card balances surpassed $1 trillion for the second consecutive quarter in early 2023, according to TransUnion. The commercial real estate sector also remains vulnerable.
Experts indicate that the banking sector is still adjusting from the impacts of COVID-19 and associated stimulus measures. Brian Mulberry of Zacks Investment Management emphasized that the provisions reflect banks’ expectations for future credit quality rather than past performance.
Looking ahead, banks anticipate slower economic growth, significant unemployment increases, and two anticipated interest rate cuts later this year. This projection raises concerns about potential delinquencies and defaults as the year progresses.
Citigroup’s CFO, Mark Mason, pointed out that the risks are particularly prevalent among lower-income consumers, who have seen their savings diminish since the pandemic. He noted that only consumers in the highest income quartile have increased their savings compared to early 2019. Individuals with lower credit scores are experiencing increased borrowing and declining payment rates, largely due to the pressures of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high between 5.25% and 5.5%, awaiting stabilization in inflation to reach its 2% target before implementing any rate cuts.
While banks brace for potential defaults, Mulberry suggests that current default rates do not indicate an impending consumer crisis. He highlights a distinction between homeowners and renters during the pandemic. Homeowners, having locked in low fixed rates, are facing less financial strain than renters, who are now contending with rental prices that have surged over 30% since 2019.
Rising grocery prices, which have increased by 25% over the same period, also exacerbate the strain on renters’ budgets.
However, a recent round of earnings reports reveal no major changes in asset quality within the banking sector. The sector continues to demonstrate strong revenues, profits, and robust net interest income, signaling resilience. Despite the challenges posed by prolonged high-interest rates, experts like Mulberry express confidence in the overall stability of the financial system, while remaining vigilant about the potential for evolving pressures.