With interest rates at their highest in over two decades and ongoing inflation affecting consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, major financial institutions including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions serve as a financial buffer to account for potential losses from credit risks, including delinquent accounts and bad debt, particularly concerning commercial real estate (CRE) loans.
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, marking a significant increase from the prior quarter, and Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging economic environment, where both secured and unsecured loans may result in greater losses. According to an analysis by the New York Federal Reserve, American households collectively owe approximately $17.7 trillion in various consumer loans, mortgages, and student loans.
Moreover, the issuance of credit cards and the corresponding delinquency rates are on the rise as individuals deplete their pandemic-era savings and turn to credit for financial support. Total credit card balances reached $1.02 trillion in the first quarter of this year, continuing a trend where cardholder balances have surpassed the trillion-dollar mark for two consecutive quarters, as reported by TransUnion. The commercial real estate sector is also facing significant challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the financial stressors on consumers originated primarily from the COVID-19 era stimulus measures.
Experts suggest that any emerging issues for banks may surface in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that the provisions reported in any quarter do not necessarily reflect the quality of credit from the previous three months but rather indicate banks’ expectations for future conditions.
As banks look ahead, they anticipate slower economic growth, an increased unemployment rate, and forecast two interest rate cuts later this year, which could lead to higher delinquency and default rates as 2023 closes.
Citi CFO Mark Mason highlighted that the economic challenges appear to predominantly affect lower-income consumers, who have seen their financial reserves diminish since the pandemic began.
“While the overall U.S. consumer remains resilient, performance and behavior vary significantly across different income levels,” Mason stated during a recent analysts’ call. He pointed out that only the highest income quartile has increased savings since early 2019, with the highest credit score customers driving spending growth and maintaining consistent payment habits. Conversely, those with lower credit scores are experiencing a sharper decline in payment rates and increasing borrowing, largely influenced by heightened inflation and interest rates.
Despite the banks’ preparations for potential defaults later in the year, Mulberry indicated that current default rates do not yet signify an impending consumer crisis. He noted a notable distinction between homeowners and renters from the pandemic period. Homeowners largely locked in low fixed-rate mortgages, insulating them from the current rate increases, while renters, who faced a rise in rental costs of over 30% from 2019 to 2023, are under more significant financial strain.
For now, the latest earnings reports suggest stability in asset quality, with robust revenues, profits, and net interest income indicating a healthy banking sector. Narron remarked, “There was nothing new this quarter in terms of asset quality,” emphasizing the resilience of the financial system. Mulberry concluded, “There is strength within the banking sector, which may not have been fully anticipated, but as long as interest rates remain high, the pressure will continue to build.”