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 financial institutions to mitigate potential losses due to credit risk, which includes defaulting loans and commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses, while Bank of America reported $1.5 billion. Citigroup’s allowance reached $21.8 billion, more than tripling its previous quarter’s reserve, and Wells Fargo allocated $1.24 billion.
These reserve increases indicate banks are preparing for a more challenging economic environment, where both secured and unsecured loans may lead to greater losses. An analysis conducted by the New York Fed revealed that American households collectively carry $17.7 trillion in consumer loans, student debt, and mortgages.
Moreover, credit card issuance and delinquency rates are rising as many consumers deplete their savings accrued during the pandemic and increasingly depend on credit. Credit card balances topped $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total balances exceeded this trillion-dollar threshold, according to TransUnion.
As the banking sector navigates the aftermath of the COVID-19 pandemic, Brian Mulberry, a client portfolio manager at Zacks Investment Management, highlighted the significance of consumer stimulus efforts that took place during that period.
However, potential issues for banks are expected in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that credit loss provisions reflect banks’ future expectations rather than past performance.
Currently, banks anticipate slowing economic growth, a rising unemployment rate, and potential interest rate cuts later this year. This environment could lead to increased delinquencies and defaults by year-end.
Citi’s CFO Mark Mason observed that red flags are primarily emerging among lower-income consumers, who have seen their savings diminish post-pandemic. He pointed out that only the top income quartile of consumers has more savings now than before the pandemic, and consumers with higher credit scores are driving growth in spending and payment rates. In contrast, those with lower credit scores are experiencing declining payment rates and higher borrowing, feeling the heat of inflation and interest rate hikes.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, holding off on rate cuts until inflation stabilizes towards its 2% target.
Although banks are preparing for an uptick in defaults in the latter half of the year, there is currently no significant indication of a consumer crisis, according to Mulberry. He is particularly focused on the differences between homeowners and renters during this period.
Despite rising rates, homeowners who secured low fixed-rate mortgages during the pandemic aren’t experiencing the same financial strain as renters, who face higher rental prices without the benefit of locked-in rates.
Nationwide rents have surged over 30% from 2019 to 2023, while grocery prices have risen by 25%, placing financial pressure on renters who are unable to keep pace with wage growth.
The recent earnings reports indicate that asset quality remains stable with no significant new issues. Strong revenues, profits, and healthy net interest income suggest that the banking sector is currently resilient.
Overall, industry experts express cautious optimism regarding the stability of the financial system. However, prolonged high-interest rates may continue to exert pressure on consumers and the banking sector alike.