As interest rates remain at their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for potential risks associated with their lending practices.
In the second quarter, major financial institutions, including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo, increased their provisions for credit losses. These provisions are funds set aside to safeguard against potential losses from credit risks, including defaults on loans and delinquent debts.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses surged to $21.8 billion by the end of the quarter, more than tripling from the previous quarter, and Wells Fargo recorded provisions of $1.24 billion.
The increase in provisions indicates that these banks are preparing for a riskier lending environment, which may lead to greater losses from both secured and unsecured loans. A recent analysis from the New York Federal Reserve highlighted that American households owe a staggering $17.7 trillion in various forms of consumer debt, including student loans and mortgages.
Rising credit card issuance and delinquency rates are also signs of strain, as many consumers are relying on credit as their pandemic-related savings diminish. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where total balances crossed the trillion-dollar threshold. Additionally, the commercial real estate sector remains vulnerable.
Industry experts note that the financial sector is still navigating challenges stemming from the COVID-19 pandemic, influenced significantly by consumer stimulus measures in the past. Brian Mulberry, a client portfolio manager at Zacks Investment Management, emphasized that the provisions reported for any given quarter may not accurately reflect current credit quality but are more indicative of banks’ future expectations.
Mark Narron from Fitch Ratings stated that banks predict slower economic growth, increasing unemployment, and potential interest rate cuts later this year, which could lead to a rise in delinquencies and defaults by the end of the year.
Citi’s CFO Mark Mason pointed out that the implications of these trends are especially pronounced among lower-income consumers, whose savings have significantly diminished since the pandemic. While the overall U.S. consumer remains resilient, behavior and performance disparities are evident across income levels. The highest-income quartile has retained more savings compared to pre-pandemic levels, whereas those in lower FICO score brackets are experiencing increased delinquency and borrowing.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting signs of stabilization in inflation to approach its 2% target before implementing anticipated rate cuts.
Experts assert that although banks are preparing for more defaults, current default rates do not yet indicate a consumer crisis. Mulberry noted a noteworthy distinction between homeowners and renters during the pandemic; homeowners benefitted from low fixed-rate mortgages while renters faced rising costs. Rental prices have surged over 30% nationwide since 2019, coupled with a 25% increase in grocery prices, placing significant strain on renters’ budgets.
Despite these challenges, the latest earnings reports indicate no alarming changes in asset quality. Strong revenues, profits, and a healthy net interest income signal that the banking sector remains robust overall. Mulberry remarked on the resilience of the financial system, though he cautioned that prolonged high interest rates could introduce more stress in the future.