With interest rates at their highest in over 20 years and inflation affecting consumers, major banks are bracing for increased risks linked to their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all boosted their provisions for credit losses compared to the previous quarter. These provisions are the funds banks set aside to cover potential losses arising from credit risks such as delinquent loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s credit loss allowance climbed to $21.8 billion, significantly higher than the previous quarter; and Wells Fargo’s provisions amounted to $1.24 billion.
These precautionary measures indicate that banks are preparing for a more volatile financial environment, where both secured and unsecured loans could result in greater losses. A recent report from the New York Federal Reserve highlighted that U.S. households collectively hold $17.7 trillion in debts related to consumer loans, student loans, and mortgages.
The issuance of credit cards is increasing, accompanied by rising delinquency rates as individuals deplete their pandemic savings and increasingly depend on credit. In the first quarter, credit card balances reached $1.02 trillion, marking the second consecutive quarter where total balances exceeded the trillion-dollar threshold. Commercial real estate (CRE) remains particularly vulnerable.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted that the banking sector is still recovering from the COVID-19 pandemic, which was characterized by extensive consumer stimulus measures.
Experts suggest that the challenges for banks may become more pronounced in the upcoming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported by banks reflect their expectations for future credit quality rather than past performance.
In the short term, banks are projecting slower economic growth, rising unemployment, and potential interest rate cuts later in the year, which could lead to increased delinquencies and defaults by year-end. Citi’s CFO, Mark Mason, remarked that the emerging risk signals appear to be more concentrated among lower-income consumers who have seen their savings diminish since the pandemic began.
Despite the overall resilience of the U.S. consumer base, Mason noted variances in performance based on income and credit ratings. He pointed out that only the highest-income quartile has increased their savings since early 2019, while those in lower FICO score brackets are struggling with payment rates, attributed to inflation and higher interest charges.
The Federal Reserve has maintained interest rates at a 23-year peak of 5.25-5.5%, awaiting stabilization in inflation metrics to approach its 2% target before executing any anticipated rate cuts.
Although banks are preparing for potential higher default rates in the latter half of the year, current default rates do not suggest an imminent consumer crisis, according to Mulberry. He observed a divergence between homeowners, who locked in low fixed-rate debts during the pandemic, and renters, who now face escalating rental costs.
With nationwide rents rising over 30% from 2019 to 2023 and grocery prices increasing by 25%, renters are experiencing significant pressure on their budgets due to stagnant wage growth.
Despite concerns, the recent earnings reports showed no alarming signs regarding asset quality. Strong revenues, profits, and robust net interest income suggest that the banking sector remains fundamentally stable.
Mulberry expressed relief at the ongoing strength of the financial system but cautioned that prolonged high-interest rates could impose greater stress in the future.