As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for heightened risks associated with their lending practices.
In the second quarter of the year, major financial institutions like JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions refer to funds set aside to mitigate potential losses from credit risks, which include defaults on loans and debt, particularly in the commercial real estate sector.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, more than tripling its reserves from the previous quarter, and Wells Fargo had provisions totaling $1.24 billion.
These increasing provisions reflect the banks’ anticipation of a riskier financial environment, where both secured and unsecured loans may lead to greater losses. According to a recent analysis by the New York Fed, Americans collectively owe $17.7 trillion in consumer, student, and mortgage loans.
Moreover, credit card issuance and delinquency rates are rising as consumers deplete their pandemic-era savings and begin relying more on credit. Credit card balances have surpassed $1 trillion for the second consecutive quarter, according to TransUnion data. The commercial real estate sector remains vulnerable as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted the lingering effects of the COVID era on banking and consumer health, highlighting the impact of stimulus measures provided to consumers.
However, officials indicate that any forthcoming issues for banks may emerge in the upcoming months. Mark Narron, a senior director with Fitch Ratings, explained that current provisions may not accurately reflect recent credit quality but rather signify banks’ expectations for the future.
Banks are currently forecasting slowed economic growth, an uptick in unemployment, and two anticipated interest rate cuts later this year, which may result in increased delinquencies and defaults as the year wraps up.
Citi’s chief financial officer, Mark Mason, observed that the warning signs are particularly evident among lower-income consumers whose savings have dwindled since the pandemic began. He pointed out a disparity where only the highest income groups have retained more savings since early 2019, while those in lower FICO score categories are experiencing declining payment rates and increased borrowing.
The Federal Reserve has sustained interest rates at a 23-year high between 5.25% and 5.5%, awaiting signs of inflation stabilizing towards its 2% target before enacting anticipated rate cuts.
Despite banks preparing for possible defaults in the latter half of the year, Mulberry noted that current default rates do not suggest a significant consumer crisis. He highlighted a distinction between homeowners, who secured favorable fixed rates during the pandemic, and renters, who have faced climbing rents without the benefit of those low rates.
Rent prices have surged by over 30% nationwide from 2019 to 2023, while grocery costs have risen by 25% in the same timeframe. Renters, many of whom are unable to keep up with these increases amid stagnant wage growth, are feeling the strain on their budgets.
For the time being, analysts assert that the latest earnings reports show no significant changes to asset quality, with strong revenues and profits indicating a healthy banking landscape. Mulberry expressed relief that the foundations of the financial system remain robust but cautioned that prolonged high interest rates could lead to increased stress on consumers and the banking sector.