As interest rates reach their highest levels in over two decades and inflation continues to affect consumers, major banks are gearing up to navigate increased risks associated with their lending practices.
In the second quarter, prominent financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions act as a financial buffer to cover potential losses from credit risks, including delinquency and bad debts, particularly related to commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup reported a total allowance for credit losses of $21.8 billion, reflecting over a threefold increase from the prior quarter, and Wells Fargo’s provisions reached $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging economic environment, where both secured and unsecured loans may lead to larger losses. According to a recent analysis from the New York Fed, total household debt in the U.S. has climbed to $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as consumers deplete their pandemic-era savings and increasingly depend on credit. TransUnion reported that credit card balances surpassed $1 trillion for the second consecutive quarter in early 2023. The commercial real estate sector also remains vulnerable.
Brian Mulberry, a portfolio manager at Zacks Investment Management, commented on the situation, stating that the banking sector is still adjusting from the impacts of COVID-19 and the stimulus measures that were implemented.
Experts warn that challenges for banks may arise in the near future. “The provisions reported in any given quarter reflect banks’ expectations for the future rather than past credit quality,” said Mark Narron, a senior director at Fitch Ratings.
Banks are anticipating slower economic growth, increasing unemployment rates, and potential interest rate cuts later this year, which could lead to more delinquencies and defaults as 2023 progresses.
Citi’s CFO Mark Mason pointed out that warning signs are particularly evident among lower-income consumers, who have seen their savings diminish since the pandemic began. He noted a disparity in savings, with only the top income quartile maintaining more savings than they had at the start of 2019. Those with higher credit scores are still spending and making payments while lower-scored customers are facing significant financial challenges due to rising inflation and interest rates.
The Federal Reserve has held interest rates at a 23-year high of 5.25-5.5%, awaiting indications of inflation stabilizing towards the central bank’s 2% target before considering any anticipated rate cuts.
Despite banks preparing for a potential increase in defaults later this year, Mulberry indicates that current default rates do not signal a consumer crisis. He is particularly focused on the contrast between homeowners and renters from the pandemic period, noting that homeowners, who locked in low fixed rates, are not experiencing financial strain, unlike renters facing escalating costs.
With a reported 30% rise in rents and a 25% increase in grocery prices from 2019 to 2023, renters, who did not secure lower rates, are under greater financial pressure, as their budgets are stretched thin.
However, the overall message from the latest earnings reports is that there are no alarming changes in asset quality. Current strong revenues and net interest income demonstrate that the banking sector remains relatively healthy.
“There’s a certain resilience in the banking sector that is reassuring, indicating the financial system’s strong foundation,” Mulberry stated. “Nevertheless, ongoing high interest rates will continue to exert pressure.”