As interest rates reach their highest levels in over 20 years and inflation pressures consumers, major banks are bracing for potential risks related to their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions are reserves set aside by financial institutions to cover potential losses from 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 reserved $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, more than tripling its reserve build from the prior quarter, and Wells Fargo set aside $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans may lead to greater losses. A recent analysis by the New York Fed revealed that Americans currently owe a collective $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards and the associated delinquency rates are also rising as individuals deplete their pandemic-era savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where total balances exceeded the trillion-dollar threshold, as reported by TransUnion. Moreover, the commercial real estate sector remains in a delicate situation.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking sector is still recovering from the COVID-19 pandemic, largely due to the stimulus measures implemented during that time.
Experts indicate that the challenges for banks could manifest in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that current provisions do not solely reflect recent credit quality but rather banks’ expectations for future conditions.
He noted a shift from historical norms, where provisions increased only after loans began to default, to a model where economic forecasts heavily influence provisioning levels. Currently, banks are anticipating slower economic growth, a rise in unemployment, and potential interest rate cuts in September and December. This scenario could lead to increased delinquencies and defaults as the year comes to a close.
Citi’s chief financial officer, Mark Mason, pointed out that the concerning trends are primarily among lower-income consumers, whose savings have diminished since the pandemic. He observed that while the overall U.S. consumer remains resilient, disparities exist based on income and credit scores. Only the highest income quartile has managed to maintain increased savings since early 2019, and customers with FICO scores above 740 are driving spending growth and high payment rates. In contrast, those in lower FICO brackets are experiencing declines in payment rates and are borrowing more due to the burdens of high inflation and interest rates.
The Federal Reserve is maintaining interest rates at a 23-year high between 5.25% and 5.5%, awaiting stabilization in inflation measures toward its 2% target before implementing anticipated rate cuts.
Despite banks preparing for a rise in defaults later this year, current trends do not indicate an imminent consumer crisis, Mulberry emphasized. He is particularly monitoring differences between homeowners and renters during the pandemic. While homeowners secured low fixed-rate mortgages, renters have faced skyrocketing rental prices without similar protections.
Rental costs have surged over 30% nationwide from 2019 to 2023, while grocery prices have risen 25%. Renters, who have not benefited from low rates, are under significant strain on their monthly budgets.
Overall, the latest earnings reports revealed no significant new issues concerning asset quality. Strong revenues and profits, along with resilient net interest income, indicate that the banking sector remains healthy. Mulberry remarked on the stability within the banking sector, noting that while the situation is positive, prolonged high interest rates could lead to increased stress moving forward.