As interest rates are at their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks in 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 represent the funds that banks allocate to cover possible losses resulting from credit risks such as overdue debts and bad loans, particularly in the commercial real estate sector.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America contributed $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, significantly more than its previous quarter’s reserve increase. Wells Fargo allocated $1.24 billion for similar purposes.
These increased provisions indicate that banks are preparing for a more challenging environment where both secured and unsecured loans could lead to larger losses. A recent analysis by the New York Federal Reserve revealed that Americans collectively owe $17.7 trillion on various loans, including consumer and student loans as well as mortgages.
Credit card usage and delinquency rates are also climbing as individuals exhaust their pandemic-era savings and depend more on credit. In the first quarter of this year, credit card balances exceeded $1 trillion for the second consecutive quarter, according to TransUnion. The commercial real estate sector is also facing significant challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted the ongoing recovery from the pandemic era, primarily influenced by government stimulus efforts directed at consumers.
However, challenges for banks are expected to emerge in the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, explained that the quarterly provisions don’t solely reflect recent credit quality but instead represent banks’ expectations for the future.
He further described a shift in the banking system where macroeconomic forecasts now heavily influence provisioning, as opposed to simply responding to bad loans.
Banks are anticipating slowing economic growth, increased unemployment, and two interest rate cuts later this year, which could lead to greater delinquency and default rates as the year wraps up.
Citi’s chief financial officer, Mark Mason, highlighted that any concerning trends appear to be largely affecting lower-income consumers, who have seen their financial reserves diminish post-pandemic.
While maintaining that the overall U.S. consumer remains resilient, Mason noted differences in financial behavior among various income groups. He indicated that only the highest income quartile has more savings than they did before 2019, while those in lower FICO score bands are experiencing drops in payment rates and increased borrowing due to higher inflation and interest rates.
The Federal Reserve has held interest rates at a 23-year high of 5.25-5.5%, waiting for inflation to stabilize toward its 2% target before making anticipated cuts.
Despite banks preparing for possible defaults later this year, Mulberry remarked that defaults are not currently escalating to levels indicative of a consumer crisis. He is particularly observing the differences in financial conditions between homeowners and renters during this period.
He pointed out that while interest rates have risen significantly, homeowners benefitted from locking in low fixed rates on their debts, thus not feeling the same financial strain. Conversely, renters, who did not have the opportunity to secure favorable rates, are increasingly affected by rising rental prices exceeding wage growth and overall rising living costs.
The recent earnings reports suggest that there have not been notable new concerns regarding asset quality. Strong revenues, profits, and robust net interest income signal a healthy banking sector, suggesting that the financial system remains strong despite ongoing challenges.
Mulberry concluded that while some resilience is evident in the banking industry, prolonged high interest rates could lead to increasing pressure on financial institutions.