As interest rates remain at their highest levels in over twenty years and inflation continues to affect consumers, major banks are preparing for increased risks associated with their lending practices.
In recent reports from the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their provisions for credit losses compared to the previous quarter. These provisions represent funds set aside by financial institutions to cover potential losses related to credit risks, including bad debt and delinquent loans, particularly in 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 reported an allowance of $21.8 billion, more than tripling its reserve from the previous quarter. Wells Fargo established provisions totaling $1.24 billion.
These increased provisions indicate that banks are bracing for a more challenging lending environment, where both secured and unsecured loans may result in larger losses. The New York Federal Reserve recently highlighted that Americans owe a combined $17.7 trillion in consumer loans, student loans, and mortgages, showcasing the heavy debt burden on households.
Additionally, credit card issuance and delinquency rates are rising as individuals begin to deplete their savings amassed during the pandemic. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances have surpassed the trillion-dollar threshold. The commercial real estate sector also faces significant uncertainties.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted the lingering effects of the COVID era on banking and consumer health, primarily influenced by government stimulus measures.
Experts indicate that the issues facing banks may arise in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions reflect banks’ future expectations rather than just recent credit quality trends.
Banks are forecasting a slowdown in economic growth, an increase in unemployment rates, and potential interest rate cuts in September and December, which could lead to higher rates of delinquency and default later this year.
Citi’s CFO Mark Mason acknowledged concerns primarily among lower-income consumers, who have seen their financial reserves shrink since the pandemic. He emphasized the disparity in saving habits, noting that only the highest income quartile has increased their savings since 2019, while consumers with lower credit scores are struggling more due to rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25% to 5.5%, waiting for inflation to stabilize closer to its 2% target before initiating anticipated rate cuts.
Despite preparations for a potential increase in defaults, reports indicate that consumer defaults have not yet surged to the level that would signify a crisis. Mulberry highlighted the contrast between homeowners and renters, noting that those who secured low fixed-rate mortgages during the pandemic are currently less affected by rising rates.
However, renters face a different reality, with rental prices rising over 30% between 2019 and 2023, compounded by a 25% increase in grocery costs during the same period, creating financial strain for those without the benefit of low fixed-rate housing costs.
Overall, this latest earnings round indicated no significant deterioration in asset quality, according to Narron. Strong revenues, profits, and resilient net interest income suggest a still-healthy banking sector, with Mulberry expressing relief at the current strength of the financial system, while cautioning that prolonged high interest rates may lead to increased stress in the future.