Amid soaring interest rates that have reached their highest point in over two decades and persistent inflation affecting consumers, major banking institutions are gearing up for increased risks associated with their lending activities.
In the second quarter, leading banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all reported an increase in their provisions for credit losses compared to the previous quarter. These provisions represent funds set aside by financial entities to offset potential losses due to credit risks, including defaults and delinquent loans, particularly in the area of commercial real estate.
Specifically, JPMorgan set aside $3.05 billion for credit losses, while Bank of America allocated $1.5 billion. Citigroup reported an allowance for credit losses of $21.8 billion, a figure which more than tripled from the previous quarter. Wells Fargo reported provisions totaling $1.24 billion.
This uptick in reserves suggests that banks are preparing for a potentially riskier lending environment, as both secured and unsecured loans may result in increased losses. According to the New York Federal Reserve, total household debt has climbed to $17.7 trillion, which encompasses consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are climbing as consumers begin to deplete their pandemic-era savings and increasingly rely on credit. Credit card balances exceeded $1 trillion in the first quarter, marking the second consecutive quarter this threshold has been crossed, according to TransUnion. The commercial real estate sector continues to face challenges as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking landscape is still recovering from the COVID-19 pandemic, which was largely supported by government stimulus programs directed at consumers.
Experts believe that any forthcoming troubles for banks will manifest in the coming months. Mark Narron, a senior director from Fitch Ratings, explained that the current quarter’s provisions do not entirely reflect the credit quality from the past three months; rather, they indicate banks’ expectations for the future.
He further elaborated on the shift in banking dynamics, stating that historically, an increase in loan defaults would lead to heightened provisions. However, the current approach is heavily influenced by macroeconomic forecasts.
In the near future, banks anticipate slower economic growth, a rise in unemployment, and potentially two interest rate cuts scheduled for September and December. These circumstances could lead to more delinquencies and defaults as the year wraps up.
Citi’s Chief Financial Officer, Mark Mason, highlighted concerning trends among lower-income consumers, who have experienced significant declines in their savings since the pandemic began.
Mason remarked on the overall resilience of U.S. consumers, noting, “We see a divergence in performance and behavior across different income segments.” He added that only the highest-earning quartile has increased their savings since 2019, while customers with lower credit scores are borrowing more and experiencing heightened financial strain due to inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it awaits stabilization in inflation metrics, moving toward the central bank’s target of 2%.
Despite banks preparing for potential defaults in the latter half of the year, Mulberry indicated that current default rates do not suggest an imminent consumer crisis. He is particularly attentive to the experiences of homeowners versus renters during this economic climate, noting that homeowners benefitted from securing low fixed rates on their mortgages while renters have been facing significant increases in living costs.
According to Mulberry, the overall rental market has surged over 30% from 2019 to 2023, alongside a 25% rise in grocery prices, placing renters under considerable financial pressure as their wages struggle to keep pace with these increased expenses.
Looking ahead, Narron observed that recent earnings reports revealed stability in asset quality. Strong revenues, solid profits, and robust net interest income are signs of a resilient banking sector. Mulberry affirmed that while the financial system remains strong and sound, ongoing high-interest rates will likely induce additional stress over time.