With interest rates reaching their highest levels in over 20 years and inflation continuing to impact consumers, major banks are bracing for increased lending risks.
In the recent second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo have all increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds set aside by these financial institutions to mitigate potential losses from credit risk, such as bad debt and lending activities, notably in commercial real estate (CRE).
Specifically, JPMorgan allocated $3.05 billion for credit losses, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses was reported at $21.8 billion, marking a significant increase from the prior quarter, and Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans could lead to more substantial losses. A recent analysis by the New York Fed revealed that American households owe a staggering $17.7 trillion across various consumer loans, student loans, and mortgages.
Credit card usage is also on the rise, with delinquency rates climbing as consumers deplete their pandemic savings and increasingly rely on credit. In the first quarter, credit card balances reached $1.02 trillion, the second consecutive quarter exceeding the trillion-dollar mark, according to TransUnion. Meanwhile, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the current banking landscape, noting that the economic turmoil stemming from the COVID-19 pandemic has affected consumer financial health significantly due to the stimulus measures that were previously enacted.
The challenges for banks may materialize in the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, explained that the provisions reflected in any quarter do not necessarily correlate with recent credit quality but rather indicate banks’ expectations for the future.
Banks are currently anticipating slower economic growth, a rise in unemployment, and two interest rate cuts later this year, which could lead to increased delinquencies and defaults by year-end.
Citigroup’s CFO Mark Mason highlighted a concerning trend among lower-income consumers who have experienced a decline in savings since the pandemic. He noted that while the overall U.S. consumer appears resilient, there are significant disparities based on income and credit scores. Only the top income quartile has managed to increase savings since 2019, while customers with lower FICO scores are experiencing a drop in payment rates and increased borrowing due to higher inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25% to 5.5% as it awaits stabilization in inflation towards its 2% target, which is necessary for anticipated rate cuts.
Despite preparing for a possible rise in defaults in the latter half of the year, analysts like Mulberry believe that current default rates do not indicate a full-blown consumer crisis. He observes a distinction between homeowners who locked in low fixed rates during the pandemic and renters who now face soaring rental costs and increased living expenses.
Rent prices have surged over 30% nationwide from 2019 to 2023, while grocery costs have risen by 25%, placing considerable strain on renters who did not benefit from low mortgage rates.
Overall, financial experts note that recent earnings reports did not reveal any significant new concerns regarding asset quality. Positive indicators for the banking sector include strong revenues, profits, and resilient net interest income. Mulberry remarked that while the banking system’s structures appear robust, the sustained high interest rates could lead to increased stress over time.