As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are anticipating increased risks linked to their lending practices.
In the second quarter, 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 that banks allocate to manage potential losses from credit risks such as bad debt and loans, including commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached a total of $21.8 billion at the end of the quarter, more than tripling its reserves from the previous quarter. Wells Fargo reported provisions of $1.24 billion.
These increased provisions indicate that banks are preparing for a more challenging environment, where both secured and unsecured lending could result in greater losses. According to a recent New York Fed analysis, Americans hold a collective debt of $17.7 trillion across consumer loans, student loans, and mortgages.
Furthermore, credit card issuance and delinquency rates are rising as individuals deplete their pandemic-era savings and depend more on credit. In the first quarter of this year, total credit card balances reached $1.02 trillion, marking the second consecutive quarter that overall cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the situation, stating that the ongoing recovery from the COVID-19 pandemic and previous stimulus measures have had lasting effects on consumer banking health.
However, challenges for banks are expected to surface in the months ahead. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that the provisions reported by banks do not necessarily reflect recent credit quality but are indicative of expected future conditions.
He explained that the banking system has shifted from reacting to worsening loan performance to one where macroeconomic forecasts more heavily influence provisions.
In the short term, banks anticipate slower economic growth, a potential rise in unemployment rates, and two expected interest rate cuts later this year, which could result in increased delinquencies and defaults by year-end.
Citi’s Chief Financial Officer Mark Mason pointed out that the warning signs primarily affect lower-income consumers who have seen their savings diminish since the pandemic. He highlighted that only the top income quartile has maintained higher savings compared to early 2019, while consumers in lower FICO score brackets are borrowing more and experiencing declines in payment rates due to inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% in hopes of stabilizing inflation towards its 2% target before implementing anticipated rate cuts.
Despite banks bracing for increased defaults, Mulberry indicated that current default rates do not yet signal a consumer crisis. He noted the contrast between homeowners, who locked in low fixed interest rates during the pandemic, and renters, who may not have enjoyed the same opportunities, as renters now face significant increases in housing costs compared to wage growth.
Rents have risen over 30% nationally from 2019 to 2023, while grocery costs have increased by 25%, placing greater strain on renters’ budgets.
Overall, the latest earnings reports indicated no significant new issues regarding asset quality, with strong revenues, profits, and resilient net interest income demonstrating the ongoing health of the banking sector. Mulberry reassured that while the banking system remains robust, sustained high interest rates could introduce more stress in the future.