As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for potential risks associated with their lending practices.
In the second quarter, leading banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. Provisions are funds set aside by financial institutions to cover anticipated losses related to credit risks, including delinquent loans and bad debts, particularly in commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance totaled $21.8 billion, marking a significant increase from the previous quarter, and Wells Fargo established provisions amounting to $1.24 billion.
These increased provisions indicate that banks are preparing for a more challenging economic landscape, where both secured and unsecured loans may lead to higher losses. A report by the New York Fed highlighted that American households collectively owe $17.7 trillion in consumer debt, including loans, student loans, and mortgages.
Moreover, credit card issuance and delinquency rates are on the rise as individuals exhaust their pandemic-era savings and increasingly rely on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter where the total surpassed a trillion dollars, as reported by TransUnion. The commercial real estate market also remains vulnerable.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the post-COVID financial landscape has been significantly influenced by the stimulus measures provided to consumers.
Experts warn that challenges for banks may emerge in future months. Mark Narron, a senior director at Fitch Ratings, indicated that current provisions reflect banks’ projections rather than recent credit quality. He noted the shift in how provisions are driven more by macroeconomic forecasts rather than a reaction to bad loans.
In the short term, banks anticipate a slowdown in economic growth, an increase in unemployment, and potential interest rate cuts in September and December. These factors could lead to more delinquencies and defaults towards the end of the year.
Citi’s chief financial officer, Mark Mason, pointed out that emerging red flags primarily affect lower-income consumers, who have seen their savings diminish since the pandemic. He stated that while overall consumer resilience remains, performance varies significantly across different income levels.
Mason highlighted that only the highest-income quartile has more savings now compared to early 2019, with high-FICO score customers contributing to spending growth and maintaining high payment rates. In contrast, consumers with lower FICO scores are experiencing a decline in payment rates and are borrowing more amid rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of between 5.25% and 5.5%, as it awaits stabilization in inflation towards its 2% target before implementing anticipated rate cuts.
Despite predictions of increased defaults later in the year, Mulberry noted that current default rates do not signal an impending consumer crisis. He is particularly observing the disparity between homeowners, who have benefited from low fixed-rate loans, and renters facing significant inflation in housing costs.
Although rental prices have surged over 30% across the nation from 2019 to 2023 and grocery expenses have risen 25%, homeowners are generally less affected due to their locked-in low rates. In contrast, renters struggling with escalating rental costs and stagnant wage growth are under more financial strain.
Overall, recent earnings reports indicate that the banking sector remains resilient, with strong revenues and net interest income suggesting stability. Narron emphasized that there have been no significant changes in asset quality, and Mulberry reassured that the financial system’s structure is still robust, though they remain cautious as prolonged high interest rates could introduce more stress in the future.