With interest rates reaching their highest levels in over 20 years and inflation continuing to affect consumers, major banks are bracing for increased risks associated with 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 are the funds banks allocate to cover potential losses due to credit risks, including unpaid debts and risky loans like those in commercial real estate.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America reported a provision of $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, more than tripling from the previous quarter, and Wells Fargo recorded $1.24 billion in provisions.
These accumulated provisions indicate that banks are preparing for a challenging environment where both secured and unsecured loans may lead to greater losses. A recent analysis by the New York Federal Reserve revealed that Americans collectively owe $17.7 trillion in consumer loans, student debt, and mortgages.
Credit card issuance and delinquency rates are both rising as individuals deplete their pandemic-era savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total balances surpassed the trillion-dollar threshold, according to TransUnion. The situation in commercial real estate remains particularly tenuous.
Experts highlight that the banking sector is still emerging from the implications of the COVID era, primarily due to the stimulus measures provided to consumers. However, any issues for banks are expected to surface in the coming months.
The provisions reported for any given quarter do not necessarily reflect the credit quality from the last three months but rather indicate banks’ expectations for future developments. This shift has led to a new dynamic where macroeconomic forecasts significantly influence provisions for bad debt.
Short-term projections from banks anticipate slower economic growth, increased unemployment rates, and potential interest rate cuts later this year in September and December. These factors could exacerbate delinquencies and defaults as the year progresses.
Citi’s chief financial officer, Mark Mason, pointed out that the warning signs are primarily evident among lower-income consumers, whose savings have declined since the pandemic began. While the overall U.S. consumer remains resilient, there is a noticeable disparity in financial performance based on credit scores and income.
Mason noted that only the highest income quartile has maintained more savings than they had at the start of 2019, and customers with scores over 740 are driving spending growth and maintaining high payment rates. In contrast, those with lower credit scores are experiencing significant drops in payment rates as they are more adversely affected by inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, waiting for inflation to stabilize at its 2% target before making anticipated rate cuts.
Despite banks preparing for a possible increase in defaults, current levels of defaults do not yet indicate a consumer crisis. Observers are particularly focused on the differences in experiences between homeowners and renters during the pandemic.
While interest rates have increased significantly, homeowners locked in low, fixed rates on their loans, allowing them to avoid financial strain. Conversely, renters who did not secure fixed rates are facing increased rental prices and rising costs for essentials, which have outpaced wage growth, leading to financial stress.
For now, the latest earnings reports indicate stable asset quality. Strong revenues, profits, and robust net interest income suggest the banking sector remains healthy.
Overall, while the banking system appears resilient, industry experts caution that prolonged high-interest rates may lead to increasing stress in the financial landscape.