As interest rates remain at their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for potential risks stemming from their lending practices.
In the second quarter, top banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions represent the amount set aside by financial institutions to cover possible losses from credit-related issues, including bad debt and commercial real estate (CRE) loans.
JPMorgan reported a provision for credit losses of $3.05 billion for the second quarter, while Bank of America earmarked $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, significantly increasing its reserves, and Wells Fargo set aside $1.24 billion.
These increased provisions indicate that banks are preparing for a challenging financial landscape, where both secured and unsecured loans might lead to greater losses. A recent report from the New York Federal Reserve highlighted that U.S. households owe a total of $17.7 trillion in consumer, student, and mortgage loans.
The rise in credit card issuance, along with increasing delinquency rates, suggests that consumers are relying more on credit as their pandemic-era savings diminish. TransUnion reported that credit card balances hit $1.02 trillion in the first quarter of the year, marking the second consecutive quarter this figure has surpassed a trillion dollars. Additionally, the CRE sector is facing instability.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, pointed to the ongoing recovery from the COVID-19 pandemic, which has been supported by consumer stimulus measures. However, challenges for banks are expected in the coming months.
Mark Narron, a senior director at Fitch Ratings, explained that current provisions are not representative of recent credit quality but are instead forecasts based on expected future conditions. He noted a shift from traditional practices where rising defaults prompted increased provisions to a model driven by macroeconomic projections.
In the short term, banks are anticipating slower economic growth, higher unemployment, and potential interest rate cuts later this year. This could lead to increased delinquency and default rates as the year ends.
Citi’s CFO Mark Mason pointed out that the economic challenges seem to be most pronounced among lower-income consumers, who have depleted their savings since the pandemic. He noted a significant disparity in savings among different income groups, with only the highest earners increasing their savings since 2019.
Despite the ongoing preparation for potential defaults, Mulberry suggests that we have not yet seen a consumer crisis emerge, as current default rates do not indicate severe issues. He highlighted the difference between homeowners who secured low fixed rates during the pandemic and renters who are currently facing rising costs.
Rent prices have surged more than 30% nationwide between 2019 and 2023, coupled with a 25% increase in grocery costs. Renters who may not have benefited from lower interest rates are facing significant financial strain.
Overall, the latest earnings reports reveal no major concerns regarding asset quality, with strong revenues and profits demonstrating a resilient banking sector. Mulberry emphasized that while the banking industry currently shows robust fundamentals, the prolonged high-interest rate environment could introduce more pressure over time.