Major banks are bracing for potential challenges in their lending practices as interest rates reach their highest levels in over 20 years and inflation continues to impact consumers.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions serve as a financial cushion against potential losses stemming from credit risk, including delinquent debts and commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses, while Bank of America allocated $1.5 billion. Citigroup’s allowance surged to $21.8 billion, reflecting a more than threefold increase in its reserves from the previous quarter. Wells Fargo recorded provisions of $1.24 billion.
These increases indicate that banks are preparing for a potentially riskier environment, where both secured and unsecured loans may lead to greater losses. A recent analysis from the New York Fed highlighted that Americans owe a total of $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise, as individuals deplete their pandemic-era savings and turn increasingly to credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter of exceeding the trillion-dollar mark, according to TransUnion. The commercial real estate sector also remains vulnerable.
“The aftermath of the COVID era is still unfolding, especially in banking and consumer health, largely due to the stimulus provided to consumers,” noted Brian Mulberry, a portfolio manager at Zacks Investment Management.
Future challenges for banks are anticipated in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions recorded in any given quarter reflect expectations about future conditions rather than past credit quality.
“Historically, provisions increased when loans deteriorated, but now macroeconomic forecasts significantly influence provisioning,” he remarked.
Banks are currently anticipating slower economic growth, higher unemployment rates, and potential interest rate cuts later this year, which could lead to increased delinquencies and defaults as the year concludes.
Citigroup’s chief financial officer, Mark Mason, pointed out that warning signs are emerging primarily among lower-income consumers, who have seen their savings diminish since the pandemic.
“While the overall U.S. consumer remains resilient, there is a notable divergence based on income and credit scores,” Mason stated during a recent analyst call. He emphasized that only the highest-income quartile has increased savings since early 2019, with consumers in the lower credit tiers experiencing a decline in payment rates and heavier borrowing, largely due to high inflation and interest rates.
The Federal Reserve maintains interest rates at a 23-year high of 5.25-5.5%, awaiting signs of inflation stabilizing towards its 2% target before implementing any anticipated rate cuts.
Despite preparing for a rise in defaults in the latter half of the year, Mulberry indicated that current default rates do not signal a consumer crisis. He suggested that a comparison of homeowners and renters during the pandemic is crucial to understanding the situation.
“Homeowners, who benefited from locking in low fixed rates, are largely insulated from current pressures,” he said. In contrast, renters are facing significant stress due to soaring rents, which rose over 30% nationally from 2019 to 2023, alongside grocery costs growing by 25%.
From the most recent earnings reports, a key takeaway is that there have been no alarming changes in asset quality. Instead, robust revenues, profits, and net interest income indicate that the banking sector remains fundamentally strong.
“There’s an underlying strength in the banking sector that is reassuring, showing that the financial system remains sound at this time,” Mulberry concluded. “However, the longer interest rates stay high, the more strain they could cause.”