As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter of the year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds set aside by financial institutions to cover potential losses due to credit risk, including delinquent debts and loans, particularly in commercial real estate.
JPMorgan allocated $3.05 billion for credit loss provisions, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, marking more than a triple increase from the previous quarter. Wells Fargo reserved $1.24 billion for credit losses.
These increased reserves suggest that banks are preparing for a riskier lending environment, where both secured and unsecured loans may lead to larger losses. A recent analysis from the New York Federal Reserve highlighted that Americans collectively owe $17.7 trillion on various types of consumer debt, including student loans and mortgages.
Additionally, credit card issuance and delinquency rates are on the rise, as Americans deplete their pandemic-era savings and turn more often to credit. Credit card balances surpassed $1.02 trillion in the first quarter, marking the second consecutive quarter of exceeding this threshold, according to TransUnion. The commercial real estate sector also remains in a precarious position.
Brian Mulberry from Zacks Investment Management noted that the banking landscape is still recovering from the COVID-19 pandemic, largely due to the consumer stimulus measures implemented during that time.
However, challenges for banks may arise in the upcoming months. Mark Narron of Fitch Ratings explained that the provisions for credit losses at any given quarter do not necessarily reflect the credit quality from the previous three months, but rather what banks anticipate for the future.
In the short term, banks are forecasting slower economic growth, a rise in unemployment rates, and two interest rate cuts expected in September and December. These factors may lead to more delinquencies and defaults by the year’s end.
Citigroup’s CFO, Mark Mason, pointed out that warning signs are particularly pronounced among lower-income consumers who have seen their savings diminish since the pandemic. He emphasized a noticeable divergence in consumer performance, highlighting that only the highest-income quartile has managed to maintain higher savings than in early 2019, with creditworthy customers driving spending growth.
The Federal Reserve has maintained interest rates at a range of 5.25-5.5%, the highest in 23 years, pending stabilization of inflation rates toward the bank’s 2% target before implementing anticipated rate cuts.
Despite banks preparing for potential increases in defaults later this year, Mulberry stated that defaults have not yet escalated to levels indicative of a consumer crisis. Observations are being made regarding the distinction between homeowners and renters during the pandemic, with homeowners benefiting from low fixed-rate debts, while renters face difficulties with rising rents.
Between 2019 and 2023, rents have surged over 30% nationally, along with a 25% increase in grocery prices within the same timeframe, putting additional pressure on renters who did not secure low rates.
Overall, the latest earnings reports indicate stability within asset quality. Strong revenues, profits, and robust net interest income demonstrate a still-healthy banking sector. Mulberry expressed relief that the financial system remains strong and sound, though he noted that sustained high-interest rates may lead to increased stress on consumers and banks alike.