Big banks are preparing to manage increased risks from their lending practices as interest rates remain at over two-decade highs and inflation continues to pressure consumers. In the second quarter, major financial institutions like JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo heightened their provisions for credit losses compared to the previous quarter. These provisions are funds set aside to cover potential losses from credit risks such as bad debts and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in this quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, marking more than a triple increase from the last quarter, and Wells Fargo reported $1.24 billion in provisions.
These increased provisions indicate that banks expect a riskier economic landscape where both secured and unsecured loans could result in larger losses. A recent analysis from the New York Fed revealed that American households collectively owe $17.7 trillion in consumer loans, mortgage debt, and student loans.
Credit card issuance and delinquency rates are on the rise as consumers deplete their pandemic savings, leading them to rely more on credit. As of the first quarter, total credit card balances reached $1.02 trillion, surpassing the trillion-dollar mark for the second consecutive quarter, according to TransUnion. The commercial real estate sector also faces challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, pointed out that as the economy recovers from the COVID-19 pandemic, unexpected challenges related to consumer health could arise from previously provided stimulus measures.
Mark Narron, a senior director at Fitch Ratings, explained that the credit provisions banks set aside do not necessarily reflect recent credit quality but rather their expectations for future economic conditions. He noted a shift from a system that increased provisions in response to loan defaults to one dependent on macroeconomic forecasts.
Currently, banks foresee a slowdown in economic growth, an increase in unemployment rates, and possible interest rate cuts later this year. This outlook raises concerns that delinquencies and defaults may rise toward the end of the year.
Citi’s CFO, Mark Mason, highlighted that potential financial issues appear to be more prominent among lower-income consumers, who have been decreasing their savings since the pandemic. He noted that only the highest-income consumers have managed to increase their savings since early 2019, with those having higher credit scores leading in spending and maintaining payment rates, while customers with lower credit scores struggle more with payment trends due to significant inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, waiting for inflation to stabilize around its 2% target before considering rate cuts.
Despite banks bracing for a rise in defaults later this year, current default rates do not yet indicate a consumer crisis. Mulberry observes a divide between homeowners during the pandemic, who secured low fixed rates, and renters who faced rising rents without enjoying that benefit.
With rents rising over 30% nationwide from 2019 to 2023 and grocery prices increasing by 25%, renters are experiencing the most financial strain due to wage growth not keeping pace with rising costs.
Overall, analysts observe strong revenues, profits, and net interest income, suggesting that the banking sector remains robust despite the pressures from the current economic climate. Mulberry cautions that the extended high-interest-rate environment may increase stress on the sector over time.