As interest rates remain at over two-decade highs and inflation continues to impact consumers, major banks are gearing up for potential risks in their lending practices.
In the second quarter, four prominent banks—JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo—raised their provisions for credit losses compared to the previous quarter. These provisions serve as a financial shield against possible losses from credit risks such as bad debts and commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter; Bank of America allocated $1.5 billion; Citigroup’s total allowance reached $21.8 billion, tripling its reserves from the prior quarter; and Wells Fargo established provisions amounting to $1.24 billion.
This increase in reserves indicates that banks are preparing for a potentially more challenging lending environment, where both secured and unsecured loans may lead to higher losses. A recent analysis by the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, along with student loans and mortgages.
Credit card issuance and delinquency rates are on the rise as many individuals exhaust their pandemic savings and increasingly depend on credit. According to TransUnion, credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where totals surpassed the trillion-dollar threshold. Similarly, the commercial real estate sector remains in a precarious state.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the situation, stating that the financial landscape is still transitioning from the impacts of COVID-19, especially regarding consumer health, largely influenced by previous stimulus measures.
However, challenges for banks may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions displayed in any quarter don’t solely reflect recent credit quality but rather banks’ expectations for future conditions.
He noted a shift from a historical approach where rising loan defaults prompted increased provisions to one where macroeconomic forecasts drive provisioning decisions. In the near term, banks anticipate sluggish economic growth, a rise in unemployment, and two anticipated interest rate cuts during September and December. This outlook could result in more delinquencies and defaults toward the year-end.
Citi’s chief financial officer, Mark Mason, highlighted that signs of distress are particularly concentrated among lower-income consumers, who have seen their financial cushions diminish since the pandemic.
“Overall, while the U.S. consumer appears resilient, we observe varied performance based on income and credit score,” he stated in a recent analyst call. He noted that only consumers in the highest income quartile have more savings than before 2019, while those with lower credit scores are experiencing declines in payment rates and increased borrowing due to the pressures of high inflation and interest rates.
Currently, the Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation towards its 2% target prior to carrying out expected rate cuts.
Despite banks preparing for an uptick in defaults later this year, Mulberry indicated that defaults are not yet rising to levels suggesting a consumer crisis. He is particularly focused on the differences between homeowners and renters during the pandemic era, noting that while homeowners benefited from low fixed rates, renters face challenges as rents surged over 30% nationwide from 2019 to 2023 and grocery prices rose by 25%.
Overall, the latest earnings reports reveal no new developments concerning asset quality. Positive indicators such as robust revenues, profits, and stable net interest income suggest that the banking sector remains in good health.
“There’s strength in the banking sector that comes as a relief, indicating that the financial system’s foundations are strong at present,” Mulberry remarked, while expressing caution that the continued high interest rates could bring additional stress.