With interest rates reaching their highest levels in over twenty years and inflation persisting, 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 reported increases in their provisions for credit losses compared to the previous quarter. These provisions are the funds set aside by banks to cover potential losses from credit risks, which include issues related to delinquent debts and lending, particularly in commercial real estate (CRE).
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, marking a significant increase from the previous quarter, and Wells Fargo’s provisions totaled $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier lending environment, where both secured and unsecured loans may lead to larger losses. A recent analysis from the New York Federal Reserve revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as consumers deplete their pandemic-era savings and turn to credit. Credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. Meanwhile, the CRE sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, pointed out that the current banking landscape and consumer health is still recovering from the impacts of COVID-19, particularly noting the stimulus measures that were previously in place.
It’s important to note that the provisions reported by banks do not solely reflect credit quality from the last quarter but also indicate expectations for the future, according to Mark Narron, a senior director at Fitch Ratings. He emphasized that the banking system has shifted to a model where macroeconomic forecasts significantly influence provisioning decisions.
In the short term, banks are anticipating slower economic growth and higher unemployment rates, along with two potential interest rate cuts later this year. This trend could lead to increased delinquencies and defaults as the year progresses.
Citi’s CFO, Mark Mason, highlighted that warning signs are particularly evident among lower-income consumers, who have seen their savings diminish since the pandemic. He noted a disparity in financial health among different income levels, with only the highest-income quartile maintaining more savings than before 2019.
The Federal Reserve is sustaining interest rates at a 23-year high of 5.25-5.5% to wait for inflation to stabilize closer to the central bank’s 2% target before implementing any rate cuts.
Despite banks preparing for potential defaults in the latter part of the year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He is observing the differences between homeowners who locked in low fixed rates during the pandemic and renters, who are now facing much higher costs.
Rent prices have surged over 30% from 2019 to 2023, while grocery prices have increased by 25% during the same period. Renters, lacking the opportunity to secure lower rates, are experiencing significant financial pressure.
For now, the latest earnings reports suggest stability within the banking sector, with no alarming shifts in asset quality. The banking industry continues to demonstrate strong revenues and profits, signaling ongoing health in the financial system. Mulberry remarked that while the banking sector shows strength, the prolonged period of high interest rates could eventually lead to increased stress within the system.