As interest rates hit their highest point in over two decades and inflation continues to strain consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, leading financial institutions including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds banks allocate to cover potential losses from credit risks, encompassing delinquent debt and loans, particularly in the commercial real estate sector.
JPMorgan set aside $3.05 billion for credit losses, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses surged to $21.8 billion by the end of the quarter, more than tripling its reserves from the prior quarter, and Wells Fargo’s provisions reached $1.24 billion.
These increased reserves indicate that banks are preparing for a challenging environment where both secured and unsecured loans could lead to larger losses. A recent analysis from the New York Fed revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are on the rise as consumers deplete their pandemic-era savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of the year, marking the second consecutive quarter in which total balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the ongoing impact of the COVID-19 pandemic, noting that the stimulus measures provided to consumers have influenced banking and consumer health.
Experts believe that any significant banking challenges will emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions recorded by banks do not necessarily reflect their current credit quality but rather their expectations for future developments.
Currently, banks anticipate slower economic growth, a higher unemployment rate, and two interest rate cuts later this year, which could lead to additional delinquencies and defaults as the year progresses.
Citi’s chief financial officer Mark Mason pointed out that the warning signs seem most pronounced among lower-income consumers, whose savings have dwindled since the pandemic. He noted that while the overall U.S. consumer remains resilient, performance diverges significantly across different income and credit score brackets.
According to Mason, only the highest income quartile has managed to increase their savings since early 2019, with higher-earning customers driving spending growth and maintaining high payment rates. In contrast, customers with lower credit scores are experiencing declines in payment rates and increasing borrowing due to the pressures of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high between 5.25% and 5.5%, awaiting stabilization of inflation measures towards the central bank’s 2% target before proceeding with anticipated rate cuts.
Despite banks preparing for a wave of potential defaults later in the year, Mulberry mentioned that the current default rate does not indicate an impending consumer crisis. He notes the distinction between homeowners and renters, stating that while interest rates have increased significantly, homeowners who secured low fixed rates are less affected.
In contrast, renters, who did not benefit from such low rates and are facing rental prices that have surged more than 30% since 2019, are experiencing the most strain in their monthly budgets, especially as grocery costs have risen by 25%.
The latest earnings reports indicate that overall asset quality remains stable, with strong revenues, profits, and robust net interest income suggesting continued health in the banking sector. Narron stated, “The banking sector shows strength that wasn’t entirely unexpected, but it is reassuring to see that the financial system remains solid.” Mulberry echoed this sentiment, noting that ongoing high interest rates could introduce more stress in the future.