Amidst interest rates at levels not seen in over two decades and persistent inflation affecting consumers, major banks are bracing for potential increased risks associated with their lending practices.
In the second quarter of the year, leading financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo elevated their provisions for credit losses. These provisions represent funds set aside by banks to cover anticipated losses resulting from credit risk, including bad debts and delinquent loans, particularly in commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the last quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, which reflects a more than threefold increase from the previous quarter. Wells Fargo’s provisions amounted to $1.24 billion.
These increased provisions indicate that banks are preparing for a riskier environment, where both secured and unsecured loans could lead to greater losses. A recent analysis from the New York Fed revealed that American households collectively owe around $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are climbing as consumers exhaust pandemic-related savings and increasingly rely on credit. Current credit card balances have reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold. The commercial real estate sector remains particularly vulnerable.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking sector is still adjusting to the aftermath of the COVID-19 pandemic, primarily influenced by consumer stimulus measures distributed during that time.
Challenges for banks may emerge in the coming months, as Mark Narron, a senior director at Fitch Ratings, points out that current provisions do not necessarily reflect the credit quality over the past three months, but instead, represent banks’ expectations for the future.
Narron notes that banks foresee a slowdown in economic growth, a rise in unemployment rates, and potential interest rate cuts later this year, which could lead to increased delinquency and default rates as 2023 draws to a close.
Citi’s Chief Financial Officer Mark Mason has observed that the vulnerabilities appear concentrated among lower-income consumers, whose savings have diminished since the pandemic.
Despite an overall resilient U.S. consumer base, Mason highlighted disparities in financial behavior across different income groups. Only the highest income quartile has managed to increase savings since early 2019, while customers with strong credit scores are driving spending growth.
In contrast, consumers with lower credit scores are experiencing larger declines in payment rates and are increasing their borrowing in response to heightened inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% while awaiting stabilization in inflation towards a 2% target before considering rate reductions.
Although banks are preparing for potential defaults in the latter half of the year, Mulberry notes that current default rates do not indicate a widespread consumer crisis. He observes a divide between homeowners, who benefitted from low fixed rates during the pandemic, and renters, who are now struggling with soaring rents, which have increased over 30% from 2019 to 2023, along with a 25% hike in grocery costs.
Despite the challenges, the recent earnings reports from banks revealed no major surprises concerning asset quality. Robust revenues and profits, as well as solid net interest income, suggest that the banking sector remains relatively healthy and resilient.
Mulberry acknowledges that while there is some strength in the banking industry, the prolonged high interest rates could intensify stress on consumers and the financial system.