As interest rates remain at their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, 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 financial buffers against potential losses stemming from credit risks, including bad debt and lending issues related to commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses rose dramatically to $21.8 billion, more than tripling its reserve build from the previous quarter, and Wells Fargo had provisions of $1.24 billion.
These increased allocations signal that banks anticipate a riskier lending environment, where both secured and unsecured loans may lead to higher losses. An analysis by the New York Federal Reserve found that American households collectively owe $17.7 trillion in consumer, student, and mortgage loans.
The issuance of credit cards and associated delinquency rates are also on the rise as consumers deplete their pandemic-era savings and increasingly rely on credit. Credit card balances surpassed $1.02 trillion in the first quarter, marking the second consecutive quarter that total balances exceeded the trillion-dollar threshold, as reported by TransUnion. Additionally, the commercial real estate sector remains vulnerable.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the lingering effects of the COVID-19 pandemic and the federal stimulus strategies have heavily influenced consumer banking health.
Analysts suggest that problems for banks may become apparent in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported in any given quarter do not solely reflect recent credit quality but rather banks’ expectations for future performance.
He added that the industry is shifting to a system where macroeconomic forecasts significantly direct provisioning practices, indicating an evolving approach to risk management.
Looking ahead, banks anticipate slowing economic growth, increased unemployment rates, and potential interest rate cuts in September and December. This could lead to higher delinquency and default rates toward the end of the year.
Citi’s chief financial officer, Mark Mason, pointed out that emerging concerns seem to be concentrated among lower-income consumers, who have experienced significant declines in savings since the pandemic.
While the overall U.S. consumer remains resilient, Mason noted variances in financial behavior across different income and credit score demographics. Only the highest-income quartile has increased its savings since early 2019, while those with lower credit scores are facing more difficulties, marked by lower payment rates and increased borrowing due to inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%. The central bank is awaiting signs of stabilization in inflation toward its 2% target before considering rate cuts.
Despite banks preparing for potential increases in defaults later this year, Mulberry observes that consumer defaults have not yet reached alarming levels that would indicate a crisis. He is particularly focused on the experiences of homeowners versus renters during the pandemic.
Mulberry explained that while interest rates have significantly increased, homeowners who secured low fixed-rate mortgages during the pandemic are less affected compared to renters who missed those opportunities. Rent prices have surged more than 30% nationally from 2019 to 2023, along with a 25% rise in grocery costs, creating financial strain for renters who have seen wage growth lag behind these price increases.
Overall, the latest earnings reports reveal no new concerns regarding asset quality. Strong revenues and net interest income indicate a still-sound banking sector. Mulberry remarked on the resilience within the banking industry, although he emphasized the need for careful monitoring as prolonged high-interest rates could exert more stress on financial institutions.