Amidst soaring interest rates, which have reached levels not seen in over two decades, and ongoing inflation impacting consumers, major banks are bracing for challenges related to their lending operations.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions represent funds that banks set aside to mitigate potential losses stemming from credit risks, including overdue debts and lending issues, particularly in the commercial real estate sector.
JPMorgan reported a $3.05 billion provision for credit losses, while Bank of America accounted for $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, more than tripling its reserves from the previous quarter, and Wells Fargo set aside $1.24 billion.
These increases in reserves indicate that banks are preparing for a potentially riskier lending environment, where both secured and unsecured loans may lead to greater losses. Recent data from the New York Fed reveals that American households collectively owe $17.7 trillion across various types of consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are climbing as individuals draw down their pandemic savings and increasingly rely on credit. Credit card balances surged to $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total balances exceeded the trillion-dollar threshold, according to TransUnion. The commercial real estate market also remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked on the continual impacts of the COVID-19 pandemic on banking and consumer health, noting the significant stimulus that had been injected into the economy.
Any potential banking challenges are anticipated in the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, highlighted that quarterly provisions do not accurately reflect recent credit quality but rather banks’ expectations for future trends.
The banks are projecting a slowdown in economic growth, a rise in unemployment, and two anticipated interest rate cuts later this year in September and December, possibly leading to increased delinquencies and defaults.
Citigroup’s CFO, Mark Mason, pointed out that concerns are particularly prevalent among lower-income consumers, who have experienced significant declines in their savings since the pandemic began. He noted that only the highest income quartile has managed to maintain greater savings since early 2019, with trends showing that consumers with higher credit scores are driving spending growth and securing higher payment rates. In contrast, customers in lower credit score bands are experiencing sharper declines in payment rates while increasingly relying on credit.
The Federal Reserve has held interest rates between 5.25% and 5.5%, the highest rate in 23 years, as it awaits signs of inflation stabilizing towards its 2% target, which would enable potential rate cuts.
Despite banks gearing up for more defaults later this year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He observed a distinction between homeowners during the pandemic and renters, noting that homeowners locked in low fixed rates and are less affected by rising interest rates, unlike renters who are facing significant rent increases.
Rents have surged over 30% nationwide from 2019 to 2023, while grocery costs have risen by 25%. Renters who did not secure low rates are experiencing the most financial strain in their monthly budgets.
Currently, the earnings reports indicate that the banking sector remains stable, with strong revenues, profits, and consistent net interest income, as noted by Narron. Mulberry expressed a sense of relief regarding the robustness of the financial system amidst high-interest rates but emphasized the need to monitor the situation closely, as prolonged high rates can lead to increased financial stress.