With interest rates reaching their highest levels in over 20 years and inflation putting pressure on consumers, major banks are bracing for increased risks in their lending strategies.
In the second quarter of the year, top banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks allocate to cover potential losses from credit risks, including delinquent loans and bad debt, particularly in areas like commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses, while Bank of America increased its provisions to $1.5 billion. Citigroup’s allowances surged to $21.8 billion, significantly higher than the previous quarter, and Wells Fargo reported provisions of $1.24 billion.
The uptick in these reserves reflects banks’ preparations for a potentially difficult lending environment, where losses from both secured and unsecured loans might escalate. Recent analyses from the New York Federal Reserve indicate that American consumers are carrying a staggering $17.7 trillion in combined debts, which include credit cards, student loans, and mortgages.
Alongside this, the issuance of credit cards and rising delinquency rates have become apparent as individuals deplete their pandemic-era savings and increasingly depend on credit. In the first quarter of this year, credit card balances topped $1.02 trillion, marking the second consecutive quarter where totals surpassed the trillion-dollar milestone, according to TransUnion. The CRE sector also remains vulnerable.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the situation is a lingering effect of the COVID-19 pandemic—largely driven by the stimulus measures that supported consumers during turbulent times.
Looking ahead, experts believe the looming challenges for banks could manifest in the coming months. As Mark Narron, a senior director within Fitch Ratings’ Financial Institutions Group notes, the provisions reported by banks reflect their future expectations more than their recent performance.
Currently, banks anticipate slower economic growth, rising unemployment, and two potential interest rate cuts later this year, which could lead to increased delinquencies and defaults as the year progresses.
Citigroup’s Chief Financial Officer Mark Mason highlighted that financial struggles appear more pronounced among lower-income consumers, whose savings have diminished post-pandemic. He noted that while overall consumer behavior seems resilient, there is a stark divide based on income levels, with only high-income individuals seeing an increase in savings since early 2019. The lower-income demographic is feeling the pinch of high inflation and rising interest rates, resulting in dropped payment rates and increased borrowing.
The Federal Reserve continues to keep interest rates within a range of 5.25-5.5%—the highest in 23 years—waiting for inflation to align with its 2% target before considering rate reductions.
However, despite the banks’ preparations for potential defaults, current data does not suggest an imminent consumer crisis, according to Mulberry. He emphasizes a distinction between individuals who owned homes during the pandemic, who benefitted from locking in low fixed rates, and renters who faced significant rental increases.
The increase in rent prices—over 30% from 2019 to 2023—coupled with a 25% rise in grocery costs during the same period has strained lower-income households significantly. While these circumstances pose challenges, the overall outlook for the banking sector remains cautiously optimistic. Current earnings reports indicate robust revenues and profits, showing resilience amidst the stress.
Narron points out that the recent earnings indicate “nothing new” in terms of asset quality, with healthy net interest income hinting at a fundamentally sound banking system. Mulberry adds a note of reassurance that while the financial system remains stable, the longer interest rates remain elevated, the more challenges will likely arise.
Overall, while there may be obstacles ahead, the banking sector demonstrates resilience, with effective management strategies and healthy operational structures, paving the way for potential recovery and stability in economic conditions moving forward.