As interest rates remain at their highest levels in over two decades and inflation continues to pressure 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 each increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds banks set aside to cover potential losses stemming from credit risks, including defaults on loans and especially in sectors like 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 reported a total allowance for credit losses of $21.8 billion by the end of the quarter, marking more than a threefold increase from the previous quarter, and Wells Fargo reserved $1.24 billion.
The increased provisions signal that banks are preparing for a more challenging economic climate, where both secured and unsecured loans may lead to substantial losses. According to the New York Fed, American households owe a staggering $17.7 trillion across various forms of debt, such as consumer loans, student loans, and mortgages.
The issuance of credit cards has surged, with delinquency rates also rising as Americans deplete their pandemic-era savings and increasingly rely on credit. In the first quarter of this year, total credit card balances reached $1.02 trillion, marking the second consecutive quarter that total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector remains particularly vulnerable.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted that recovery from the COVID-19 pandemic is ongoing, largely due to the stimulus measures provided to consumers.
Looking ahead, challenges for banks are anticipated. Mark Narron, a senior director at Fitch Ratings, emphasized that current provisions do not necessarily indicate recent credit quality but rather reflect banks’ expectations for the future.
He remarked on the shift from a system where provisions increased only after loans began to perform poorly to one where macroeconomic forecasts heavily influence provisioning strategies.
In the short term, banks project a slowdown in economic growth, a rise in unemployment rates, and potential interest rate cuts expected later this year, which could lead to increased delinquencies and defaults.
Citigroup’s Chief Financial Officer, Mark Mason, pointed out that warning signs of financial stress are primarily evident among lower-income consumers, who have seen their savings diminish since the pandemic.
“Despite a resilient overall U.S. consumer, we are observing a significant divergence in performance and behavior based on income and credit scores,” Mason stated during an analyst call. “Only the top income quartile have more savings now compared to early 2019, while borrowers with lower credit scores are experiencing a decline in payment rates and are increasingly reliant on credit, directly impacted by high inflation and interest rates.”
The Federal Reserve has maintained interest rates at a 23-year high, ranging from 5.25% to 5.5%, as it awaits stabilization of inflation to approach its 2% target before implementing anticipated rate cuts.
While banks are preparing for potential increases in defaults, current trends do not suggest an immediate consumer crisis. Mulberry is particularly monitoring the differences between homeowners and renters, noting that homeowners, who locked in low fixed rates during the pandemic, are not feeling immediate financial pressure, unlike renters who are facing escalating costs.
With rents increasing more than 30% nationwide from 2019 to 2023 and grocery prices surging by 25%, renters who missed the opportunity to secure low rates are feeling the pinch in their monthly budgets.
Despite these concerns, the latest earnings reports indicated no significant changes in asset quality, with strong revenues and robust net interest income reflecting a still-healthy banking sector. Mulberry concluded that there is a degree of resilience within the banking system, although prolonged high-interest rates could lead to increased stress.