With interest rates at their highest in over two decades and inflation impacting consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, major financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside to cover potential losses from credit risks, including delinquent debts and loans in categories such as commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses was $21.8 billion by the end of the quarter, more than tripling its reserves from the previous period, and Wells Fargo’s provisions totaled $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans may lead to greater losses. A recent analysis from the New York Federal Reserve highlighted that American households have accumulated a total of $17.7 trillion in consumer debts, which includes loans for mortgages and student loans.
The rise in credit card issuance, along with an increase in delinquency rates, suggests that consumers are increasingly reliant on credit as their pandemic savings begin to diminish. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter where total credit card balances have surpassed the trillion-dollar threshold. Additionally, the commercial real estate sector remains in a vulnerable position.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the ongoing challenges in banking and consumer health are largely influenced by the stimulus measures that have been deployed to individuals during the pandemic.
Looking ahead, banks might encounter more difficulties. Mark Narron from Fitch Ratings explained that the provisions reported in any quarter do not necessarily reflect the credit quality from the last three months; rather, they indicate banks’ expectations for the future.
He noted a shift in the economy, where macroeconomic forecasts are increasingly guiding the provisioning process, a significant change from the past when loan defaults dictated these provisions.
In the near future, banks are forecasting slower economic growth, a rise in the unemployment rate, and expected interest rate cuts in September and December, which could lead to an increase in delinquencies and defaults.
Citi’s chief financial officer, Mark Mason, pointed out that these concerning trends are primarily observed among lower-income consumers, whose financial resources have dwindled since the pandemic.
While the overall U.S. consumer remains resilient, Mason highlighted stark differences in financial stability across various credit score and income levels. Only consumers in the top income quartile have managed to maintain their savings since early 2019, with only those holding high credit scores contributing to spending growth and high payment rates. Conversely, those in lower credit score bands are experiencing a significant decline in payment rates while accumulating more debt due to the pressing effects of inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation indicators towards a target of 2% before implementing anticipated rate cuts.
Despite banks preparing for a potential increase in defaults in the latter half of the year, Mulberry noted that defaults have not yet risen significantly enough to signal a consumer crisis. He emphasized the impact of the pandemic-era housing market on homeowners and renters, mentioning that homeowners secured low fixed-rate mortgages, insulating them from current rate increases, unlike renters who are facing soaring rental prices.
Rental costs have surged over 30% nationally from 2019 to 2023, alongside a 25% increase in grocery prices, putting considerable pressure on renters who haven’t benefited from the lower interest rates homeowners secured.
Overall, the key observation from the latest earnings reports is that there are no alarming changes in asset quality, according to Narron. Strong revenues, profits, and robust net interest income reflect a banking sector that remains in good health.
Mulberry acknowledged the solid foundation of the financial system but cautioned that prolonged high interest rates may exacerbate the challenges faced by consumers.