With interest rates at their highest levels in over two decades and persistent inflation affecting consumers, major banks are bracing for increased risks in their lending operations.
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 funds that institutions set aside to manage potential losses from credit risks, including bad debts and lending, particularly in the commercial real estate sector.
JPMorgan allocated $3.05 billion for credit losses, Bank of America set aside $1.5 billion, Citigroup’s allowance reached $21.8 billion—tripling its reserves from the prior quarter—and Wells Fargo reported provisions of $1.24 billion.
The increased reserves indicate that banks are preparing for a riskier financial landscape, where both secured and unsecured loans may lead to significant losses. An analysis from the New York Fed revealed that American households collectively owe $17.7 trillion across various consumer loans, student loans, and mortgages.
Additionally, the rise in credit card issuance and delinquency rates signifies that consumers are increasingly relying on credit as their pandemic savings diminish. Credit card balances climbed to $1.02 trillion in the first quarter, marking the second consecutive quarter where totals surpassed the trillion-dollar threshold, as reported by TransUnion. Moreover, the commercial real estate sector faces ongoing challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the ongoing economic recovery from the pandemic, noting that the previous stimulus significantly impacted consumer banking health.
Future challenges for banks are anticipated in the coming months. Mark Narron, a senior director with Fitch Ratings, explained that quarterly provisions do not solely reflect the recent credit quality but are also based on banks’ future expectations.
Banks foresee slowing economic growth, a rise in unemployment rates, and expect two interest rate cuts later this year, which could lead to increased delinquencies and defaults as 2023 concludes.
Citi’s chief financial officer, Mark Mason, pointed out that the emerging challenges are mainly affecting lower-income consumers whose savings have declined since the pandemic. He noted a noticeable disparity among consumers based on income levels, where only the highest income quartile has managed to increase their savings since early 2019. Higher FICO score customers continue to drive spending growth, while lower FICO score customers are seeing an increase in borrowing and a decline in payment rates due to the impacts of inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation figures towards its 2% target before implementing anticipated rate cuts.
Despite preparing for potential defaults later in the year, Mulberry indicated that current default rates do not signal an impending consumer crisis. He is particularly observing the differences between homeowners and renters. Homeowners, having secured low fixed-rate mortgages, are generally not experiencing the same financial distress as renters who are facing rising rents and inflation.
From the latest earnings reports, it appears the banking sector remains robust, with strong revenues, profits, and stable net interest income. Mulberry emphasized the inherent strength of the financial system while cautioning that prolonged high interest rates could escalate stress levels in the economy.