As interest rates remain at their highest level in over 20 years and inflation continues to pressure consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, leading banks including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo have all increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside to mitigate potential losses from credit risks, which include delinquent debts and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses surged to $21.8 billion, significantly more than the prior quarter, and Wells Fargo recorded provisions amounting to $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging financial environment, where both secured and unsecured loans may lead to greater losses. The New York Federal Reserve’s recent analysis shows that American households hold a total of $17.7 trillion in consumer, student, and mortgage debt.
Credit card usage is on the rise, leading to higher delinquency rates as consumers deplete their pandemic savings and increasingly rely on credit. In fact, credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter with balances exceeding that threshold, according to TransUnion. The commercial real estate sector continues to face uncertainty as well.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the financial landscape is still adjusting post-COVID, primarily influenced by consumer stimulus measures that have been implemented.
Experts warn that challenges for banks may emerge in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that current provisions do not necessarily reflect past credit quality but rather banks’ expectations for the future.
He noted a shift in historical practices where poor loan performance would lead to increased provisions; now, macroeconomic forecasts play a crucial role. Currently, banks anticipate a slowdown in economic growth, a rise in unemployment rates, and two potential interest rate cuts later this year, which could generate more delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, highlighted that these challenges appear to be most pronounced among lower-income consumers, who have seen their savings diminish since the pandemic. He pointed out that while the overall U.S. consumer remains resilient, there is a notable disparity in financial performance linked to income and credit scores.
Mason mentioned, “Only the highest income quartile has more savings than they did at the beginning of 2019,” adding that consumers with higher credit scores are driving spending growth and maintaining high payment rates. In contrast, those with lower credit scores are borrowing more and experiencing significant declines in payment rates due to inflation pressures.
The Federal Reserve has maintained interest rates at between 5.25% and 5.5% for 23 years, awaiting signs that inflation is stabilizing toward the central bank’s 2% target before considering anticipated rate cuts.
Despite banks preparing for a potential increase in defaults later in the year, the current default rates do not indicate a looming consumer crisis. Mulberry noted the difference between homeowners and renters during the pandemic, stating that while property owners secured low fixed rates on their debts, renters did not have the same advantage.
He emphasized that renters are facing significant pressures with rent rising more than 30% from 2019 to 2023 and grocery prices increasing by 25% in the same period, as their rental costs outpace wage growth.
For now, the key takeaway from the recent earnings reports is that asset quality remains stable. Strong revenue, profits, and robust net interest income suggest a healthy banking sector. Mulberry concluded by expressing relief that the financial system remains sound, though he cautioned that prolonged high-interest rates could introduce more stress.