As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for potential risks associated with 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 are funds set aside by financial institutions to cover possible losses from credit risks, such as bad debt and loans, including commercial real estate loans.
JPMorgan added $3.05 billion to its provision for credit losses; Bank of America set aside $1.5 billion; Citigroup’s credit loss allowance reached $21.8 billion, more than tripling the previous quarter; while Wells Fargo allocated $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans may result in greater losses. A recent analysis by the New York Federal Reserve disclosed that American households collectively owe $17.7 trillion across various types of loans, including consumer and student loans as well as mortgages.
Furthermore, the issuance of credit cards and the associated delinquency rates are rising, as individuals begin to deplete their pandemic-era savings and increasingly depend on credit. By the first quarter of this year, credit card balances had climbed to $1.02 trillion, marking the second consecutive quarter in which total cardholder balances surpassed a trillion dollars, according to TransUnion. Additionally, the commercial real estate sector continues to face significant challenges.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the effects of the COVID-19 pandemic and the extensive stimulus measures aimed at consumers are still being felt within the banking sector and the overall health of consumers.
However, potential banking issues are anticipated in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions do not necessarily represent recent credit quality, but rather reflect banks’ expectations for the future. He noted a shift in the system, where macroeconomic forecasts are now a driving factor for provisioning, as opposed to the historical method of reacting to loan problems.
In the short term, banks are predicting slower economic growth, higher unemployment rates, and potential interest rate cuts later this year in September and December, which could result in increased delinquencies and defaults as the year comes to a close.
Citi’s CFO Mark Mason remarked that warning signs are emerging particularly among lower-income consumers, whose savings have decreased since the pandemic. He highlighted a divergence in spending behaviors among different income levels, stating that only the highest income earners have maintained savings since early 2019. Those with lower credit scores are experiencing a decline in payment rates while relying more on credit, notably due to inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation measures toward the central bank’s 2% target before implementing anticipated rate cuts.
Despite the banks’ preparations for increased defaults later in the year, Mulberry noted that defaults have not yet escalated to a level indicating a consumer crisis. He is particularly observing the difference between homeowners and renters during this period. While interest rates have increased significantly, homeowners locked in low fixed rates and are less affected, in contrast, renters have not had the same opportunity.
With rental prices rising over 30% nationwide from 2019 to 2023 and grocery costs increasing by 25% in that timeframe, renters, who face price hikes that exceed wage growth, are experiencing the most financial strain.
Ultimately, the latest earnings reports indicate that “there was nothing new this quarter in terms of asset quality,” Narron asserted. Strong revenues, profits, and a resilient net interest income suggest that the banking sector remains relatively healthy.
“There’s some strength in the banking sector that wasn’t entirely unexpected, but it’s reassuring to see that the financial system’s structures are still robust at this time,” Mulberry added. “However, as long as interest rates remain at elevated levels, the more pressure the system will experience.”