As interest rates remain at their highest levels in over two decades and inflation continues to challenge consumers, major banks are preparing for increased risks in their lending practices.
In the second quarter of the year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds banks set aside to cover potential losses from credit risks, such as delinquent loans and bad debts, particularly in areas like commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s credit loss allowance reached $21.8 billion by the end of the quarter, significantly more than its previous reserve build. Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier environment, where both secured and unsecured loans may lead to greater losses. An analysis from the New York Fed revealed that American consumers owe a staggering $17.7 trillion across various loans, including consumer and student loans and mortgages.
Moreover, the rise in credit card issuance and delinquency rates highlights the challenges consumers face as pandemic-era savings dwindle and reliance on credit grows. Credit card balances hit $1.02 trillion in the first quarter of this year, continuing a trend of exceeding the trillion-dollar mark for two consecutive quarters. Additionally, the commercial real estate sector remains in a vulnerable position.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that as the economy rebounds from the COVID-19 era, the stimulus provided to consumers has highlighted the current state of banking and consumer financial health.
However, bank officials warn that any potential issues may not manifest until later in the year. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, emphasized that current provisions reflect future expectations rather than past credit quality.
Banks are anticipating slowing economic growth, an increase in unemployment, and two interest rate cuts scheduled for later this year in September and December. These factors could contribute to higher delinquencies and defaults as the year ends.
Citi’s CFO Mark Mason pointed out that the warning signs seem to be mainly affecting lower-income consumers, who have seen their savings diminish since the pandemic began.
“While we see overall resilience in the U.S. consumer, performance remains varied across different income groups and credit scores,” Mason stated during an analysts’ call earlier this month. He explained that only the highest income quartile has maintained savings above pre-pandemic levels, while lower credit score consumers are increasingly borrowing and experiencing payment difficulties due to economic pressures.
The Federal Reserve has maintained interest rates at a 23-year peak of 5.25-5.5% as it waits for inflation to stabilize at around 2%, signaling potential rate cuts in the future.
Despite these preparations for increased defaults, Mulberry noted that there hasn’t yet been a significant rise in default rates indicating a consumer crisis. He highlighted the difference in experiences between homeowners and renters during the pandemic, noting that homeowners, who locked in low fixed-rate mortgages, are generally less affected by current economic challenges compared to renters.
Rents have surged by over 30% nationwide from 2019 to 2023, and grocery prices have risen by 25% during the same period. Renters, unable to secure low rates, are experiencing heightened financial strain.
For the time being, the most significant takeaway from the recent earnings reports is that there have been no alarming developments in asset quality. The banking sector has shown strong revenues, profits, and robust net interest income, reflecting a fundamentally healthy industry.
“There’s strength in the banking sector that may have been somewhat expected, providing reassurance that the financial system remains solid and stable,” Mulberry remarked. “However, prolonged high interest rates are likely to create increasing stress.”