With interest rates reaching their highest levels in over two decades and inflation putting pressure on consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, prominent banks like JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo have all increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds set aside by financial institutions to cover potential losses from credit risks, which include bad debts and delinquent loans, particularly in the commercial real estate sector.
JPMorgan allocated $3.05 billion for credit losses during the second quarter, 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, marking a more than tripling of its reserves from the preceding quarter. Wells Fargo provisioned $1.24 billion.
These increased reserves reflect the banks’ cautious stance as they anticipate a more challenging economic environment, where both secured and unsecured loans may lead to higher losses. A recent assessment by the New York Fed revealed that Americans hold a staggering total of $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are climbing as households deplete their pandemic-era savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter, marking the second consecutive quarter where total balances surpassed the trillion-dollar threshold, as reported by TransUnion. The commercial real estate sector remains in a delicate state.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, emphasized that the financial sector is still navigating the ramifications of the COVID-19 pandemic, particularly regarding consumer health and banking. He noted that the significant stimulus during the pandemic has influenced current conditions.
However, challenges for banks are expected to emerge in the upcoming months. Mark Narron, a senior director at Fitch Ratings, pointed out that the provisions reported in any given quarter are not necessarily indicative of recent credit quality but rather reflect banks’ future expectations.
Banks are presently forecasting slower economic growth and a rise in unemployment, with anticipated interest rate cuts in September and December. This projection suggests the possibility of increased delinquencies and defaults as the year closes.
Citi’s chief financial officer, Mark Mason, highlighted that the risks appear to be concentrated among lower-income consumers, whose savings have significantly decreased since the pandemic began.
Despite an overall resilient U.S. consumer environment, Mason noted disparities in financial health across different income levels. He observed that only the highest income quartile has managed to increase their savings since 2019, primarily driven by customers with high FICO scores who continue to spend and maintain strong payment rates. In contrast, lower FICO score customers are experiencing reduced payment rates and increased borrowing, largely due to the burdens of heightened inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year peak of 5.25-5.5%, holding off on potential rate cuts until inflation shows signs of stabilizing towards their target of 2%.
While banks are preparing for potential defaults in the latter part of the year, current default rates do not indicate an imminent consumer crisis, according to Mulberry. He is particularly focused on the differences between pandemic homeowners and renters. Homeowners, who often locked in low fixed rates, may not feel as much financial strain compared to renters facing surging costs.
With nationwide rents rising over 30% and grocery costs up 25% between 2019 and 2023, renters are feeling the financial challenge the most, as they have not benefited from low-rate financing.
Currently, the earnings reports reflect that asset quality remains stable. Strong revenues, profitable performances, and resilient net interest income are encouraging signs of a robust banking sector.
Overall, there appears to be a stability within the banking system, though experts warn that prolonged high interest rates could potentially introduce more stress over time.