As interest rates reach levels not seen in over two decades and inflation continues to impact consumers, major banks are bracing for potential risks stemming from their lending practices.
In the second quarter of this 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 essentially reserves that banks set aside to manage potential losses arising from credit risks, including delinquent loans and commercial real estate loans.
Specifically, JPMorgan set aside $3.05 billion for credit losses during the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, significantly more than the previous build-up. Wells Fargo also reported provisions totaling $1.24 billion.
These increased provisions indicate that banks are preparing for a more uncertain lending environment, where both secured and unsecured loans might lead to more significant losses. A recent study from the New York Federal Reserve revealed that Americans collectively owe $17.7 trillion in consumer loans, student debt, and mortgages.
Furthermore, credit card issuance and delinquency rates are climbing, as many individuals deplete their savings amassed during the pandemic and increasingly rely on credit. The total credit card balances hit $1.02 trillion in the first quarter of 2023, marking the second consecutive quarter in which the overall balance surpassed the trillion-dollar mark, according to TransUnion. The commercial real estate sector remains particularly vulnerable as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the current banking landscape, stating that the impact of stimulus measures during the COVID-19 pandemic continues to shape consumer behavior.
However, challenges for banks may manifest in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, pointed out that current provisions reflect banks’ expectations for the future rather than credit quality from the past three months.
He noted a shift from a historical approach where rising delinquencies prompted increased provisions, to a model where macroeconomic forecasts are driving provisioning decisions.
In the near future, banks anticipate slower economic growth, higher unemployment, and possibly two interest rate cuts later this year, which could contribute to increased delinquencies and defaults.
Citi’s CFO Mark Mason highlighted that the risks appear to be concentrated among lower-income consumers, particularly those who have seen their savings diminish since the pandemic. He reported that only the highest income quartile demonstrates an increase in savings compared to pre-2019 levels, while consumers with lower credit scores are struggling more with high inflation and interest rates.
The Federal Reserve has held interest rates steady at a 23-year high between 5.25% and 5.5%, awaiting signs of inflation stabilizing toward its 2% target before implementing anticipated rate cuts.
Despite the banks’ preparations for a possible rise in defaults later this year, they have not yet seen significant increases that would indicate a consumer crisis, according to Mulberry. He is particularly focused on the differing experiences of homeowners versus renters during this period.
While interest rates have risen substantially, homeowners who secured low fixed rates on their mortgages are less affected, whereas renters are facing heightened costs, with rental prices surging over 30% nationally from 2019 to 2023 and grocery costs rising by 25%.
As it stands, the most significant takeaway from the recent earnings reports is that there were no new concerns regarding asset quality. Positive indicators like strong revenue, profits, and resilient net interest income suggest that the banking sector remains healthy.
Mulberry expressed relief that the financial system remains robust and sound, noting, “The longer that interest rates stay at this high of a level, the more stress it causes.”