As interest rates remain at their highest levels in over 20 years and inflation continues to pressure consumers, major banks are gearing up for increased risks in their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo each increased their provisions for credit losses compared to the previous quarter. These provisions serve as a financial cushion for banks to address potential losses related to credit risks, including delinquent debts and lending activities such as commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s credit loss allowance reached $21.8 billion, marking a significant increase from the previous quarter, and Wells Fargo recorded provisions of $1.24 billion.
These increased provisions signal that banks are preparing for a challenging environment where both secured and unsecured loans could lead to greater losses. A recent analysis by the New York Federal Reserve revealed that Americans owe a staggering $17.7 trillion across various forms of consumer debt, including loans and mortgages.
Furthermore, credit card issuance and delinquency rates are also on the rise as many individuals exhaust their pandemic-era savings and increasingly rely on credit. Total credit card balances exceeded $1 trillion in the first quarter of this year, continuing a trend for the second consecutive quarter, according to data from TransUnion. The commercial real estate sector is also navigating a difficult landscape.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, highlighted that the ongoing recovery from the COVID-19 pandemic heavily influences consumer banking health, particularly considering the significant stimulus that supported consumers during the crisis.
Challenges for banks, however, may emerge in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that the provisions reported by banks reflect their expectations about future credit quality rather than just recent performance.
Banks are anticipating slower economic growth, a rise in unemployment, and two expected interest rate cuts later this year, which could lead to increased delinquencies and defaults as 2023 comes to a close.
Citi’s Chief Financial Officer Mark Mason observed that the risk signals are particularly evident among lower-income consumers, who have seen their savings decline since the pandemic began. He stated that the overall U.S. consumer remains resilient, but performance varies significantly among different income groups. Only the highest income quartile has managed to maintain higher savings since 2019, while those in lower FICO score bands are increasingly struggling as they face the dual pressures of inflation and rising interest rates.
The Federal Reserve currently holds interest rates at a range of 5.25-5.5%, the highest in 23 years, as it awaits stabilization in inflation metrics before considering the anticipated rate cuts.
Despite banks bracing for an uptick in defaults in the latter part of the year, the current increase in defaults is not yet indicative of a consumer crisis, according to Mulberry. He emphasized the distinction between homeowners and renters during the pandemic, noting that while homeowners benefited from locked-in low fixed rates, renters are now facing significantly higher rental costs.
Rental prices have surged more than 30% nationwide from 2019 to 2023, and grocery costs have risen by 25% during the same period. Renters, who did not have the same opportunities as homeowners, are experiencing more strain on their budgets.
Overall, the most recent earnings reports from banks revealed no new concerns regarding asset quality. Despite the potential challenges ahead, strong revenues, profits, and solid net interest income reflect a banking sector that remains robust.
Mulberry expressed relief at the current strength of the financial system, asserting that while some resilience is evident, the prolonged high levels of interest rates may continue to exert stress on the sector.