With interest rates reaching the highest levels in over two decades and inflation continuing to pressure consumers, major banks are gearing up to deal with heightened 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 represent the capital banks set aside to offset potential losses from credit risks, including bad debts and loans, particularly in commercial real estate (CRE).
Specifically, JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s total allowance for credit losses soared to $21.8 billion by the end of the quarter, more than tripling its reserve build from the prior quarter; and Wells Fargo provided $1.24 billion.
This accumulation of provisions indicates that banks are preparing for a more uncertain financial environment where both secured and unsecured loans may lead to larger losses for the nation’s largest banking institutions. The New York Fed recently reported that Americans owe a staggering $17.7 trillion on various forms of consumer debt, including loans and mortgages.
Furthermore, credit card issuance and delinquency rates are rising as individuals deplete their pandemic-era savings and increasingly depend on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. The situation in commercial real estate continues to be precarious.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector and consumer health are still adjusting in the wake of the COVID-19 pandemic, during which significant stimulus funds were directed to consumers.
However, potential challenges for banks are anticipated in the coming months. Mark Narron, a senior director at Fitch Ratings, emphasized that the provisions reported by banks do not necessarily reflect current credit quality but rather their expectations for future conditions.
As banks foresee a slowdown in economic growth, an increase in unemployment, and two anticipated interest rate cuts in September and December, the risk of delinquencies and defaults seems to be on the rise.
Citigroup’s chief financial officer, Mark Mason, observed that signs of distress are particularly focused on lower-income consumers, who have experienced a significant reduction in their savings since the pandemic.
Even with an overall resilient U.S. consumer landscape, Mason highlighted a growing disparity in performance among different income brackets and credit scores. He pointed out that only the highest income quartile has managed to increase their savings since 2019, while customers with lower credit scores are increasingly facing challenges in making payments and are borrowing more due to the pressures of high inflation and interest rates.
The Federal Reserve has maintained interest rates between 5.25% and 5.5%, the highest in 23 years, awaiting stabilization in inflation metrics toward a target of 2% before implementing expected rate cuts.
Despite banks bracing for a potential increase in defaults later this year, Mulberry indicated that current default rates do not suggest an impending consumer crisis. He noted a critical distinction between homeowners who secured low fixed rates during the pandemic and renters who did not have the same opportunity, leaving them more vulnerable to financial strain.
With rents increasing over 30% nationally from 2019 to 2023 and food prices rising by 25% in the same timeframe, renters are facing significant budgeting challenges, according to Mulberry.
For now, the latest earnings reports suggest no new concerns regarding asset quality. Strong revenues, profits, and robust net interest income indicate that the banking sector remains largely healthy.
Mulberry expressed that while there are positive signals within the banking system, the ongoing high-interest rates could lead to increased stress over time.