With interest rates reaching their highest levels in over 20 years and inflation affecting consumers, major banks are getting ready to navigate potential 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 funds that financial institutions allocate to cover potential losses from credit risks, which include delinquent debts and various loans, such as commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter; Bank of America allocated $1.5 billion; Citigroup’s credit loss allowance rose to $21.8 billion by the end of the quarter, more than tripling its reserves from the previous quarter; and Wells Fargo set aside $1.24 billion.
These increased provisions indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans could lead to larger losses for some of the country’s biggest banks. A recent analysis of household debt by the New York Federal Reserve revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also climbing as individuals exhaust their pandemic-era savings and increasingly rely 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. Additionally, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted the lingering effects of the pandemic on consumer health and banking, emphasizing the impact of stimulus efforts.
However, potential challenges for banks may arise in the months ahead. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that the provisions reported at any given time may not necessarily reflect recent credit quality but instead indicate future expectations.
He highlighted a notable shift in practice: the current environment relies more on macroeconomic forecasts rather than just reactions to loans that have already begun to fail.
In the short term, banks anticipate slower economic growth, an increase in unemployment rates, and two interest rate cuts expected in September and December, which could lead to more delinquencies and defaults by year-end.
Citigroup’s CFO, Mark Mason, pointed out that the warning signs are particularly evident among lower-income consumers, who have seen their savings diminish since the pandemic.
While the overall U.S. consumer remains resilient, Mason noted a divergence in financial performance based on income levels. He indicated that only consumers in the highest income bracket have managed to save more compared to early 2019, while those in lower income sectors have experienced greater borrowing and declining payment rates due to the pressures of inflation and high interest rates.
The Federal Reserve has maintained a 23-year-high interest rate of 5.25-5.5%, awaiting a stabilization of inflation towards its 2% target before implementing anticipated rate cuts.
Despite preparations for potential defaults later in the year, experts like Mulberry do not currently see a significant rise in defaults that signals a consumer crisis. He is observing the contrast between homeowners and renters during the pandemic.
Even though interest rates have increased substantially, homeowners generally secured low fixed-rate mortgages, which alleviates immediate financial stress compared to renters who did not have that opportunity. Rents have surged more than 30% from 2019 to 2023, and grocery prices have jumped 25%, putting renters under considerable financial strain, especially with wage growth unable to keep pace.
The latest earnings reports suggest that there are no new issues in terms of asset quality. Strong revenues, profits, and resilient net interest income suggest that the banking sector remains robust.
Mulberry observed that while some stability exists within the banking sector, the ongoing high interest rates could induce more stress over time.