As interest rates remain at their highest levels in over two decades and inflation continues to impact consumers, major banks are preparing for increased risks associated with 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 are funds set aside by banks to cover potential losses from credit risk, including delinquent debt and trouble with lending, particularly in 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 $21.8 billion by the end of the quarter, which more than tripled its credit reserve from the previous quarter. Wells Fargo’s provisions totaled $1.24 billion.
These increased reserves indicate that banks are bracing for a more challenging economic climate, where both secured and unsecured loans could lead to greater losses for some of the country’s largest financial institutions. A recent report from the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
There is also a rise in credit card issuance and delinquency rates as consumers are depleting their savings from the pandemic and increasingly relying on credit. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that balances exceeded the trillion-dollar threshold. Meanwhile, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted the ongoing effects of the COVID era on the banking sector and consumer financial health, highlighting the significant stimulus deployed during that time.
As for potential issues facing banks, experts suggest that these problems could emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, indicated that the provisions banks report in any given quarter reflect not just recent credit quality but their expectations for future conditions.
Banks are currently forecasting slower economic growth, an increased unemployment rate, and potential interest rate cuts later this year, which might lead to higher rates of delinquency and defaults by year-end.
Citigroup’s CFO Mark Mason pointed out that the warning signs seem to primarily affect lower-income consumers, who have seen their savings diminish since the pandemic. He highlighted a trend where only the top income quartile has more savings now than in early 2019, with higher credit score customers driving spending growth, while those with lower credit scores face declining payment rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation toward its 2% target before implementing anticipated rate cuts.
Despite preparations for increased defaults in the latter part of the year, current default rates do not indicate a consumer crisis, according to Mulberry. He noted a divide between homeowners and renters during the pandemic; homeowners locked in low fixed rates, whereas renters are experiencing significant financial pressure.
From 2019 to 2023, rents increased over 30% and grocery costs surged by 25%, placing an additional strain on renters who could not capitalize on low rates.
However, the latest earnings reports show no new issues concerning asset quality, with strong revenues, profits, and net interest income suggesting a still robust banking sector. Mulberry remarked that the resilience of the financial system is reassuring, yet cautioned that prolonged high interest rates could lead to further stress.