As interest rates soar to their highest levels in over two decades and inflation pressures consumers, major banks are bracing for increased risks associated with their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all heightened their provisions for credit losses compared to the previous quarter. These provisions represent the funds that financial institutions allocate to cover potential losses linked to credit risks, including defaulting loans and poor debt outcomes involving areas like commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America accounted for $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, significantly more than the previous quarter’s reserve, and Wells Fargo reported provisions totaling $1.24 billion.
These increased provisions indicate that banks are preparing for a riskier environment where both secured and unsecured loans may lead to greater losses. Analysis from the New York Fed highlights that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card usage and delinquency rates are also rising as people deplete their pandemic-era savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total balances exceeded the trillion-dollar threshold, according to TransUnion. The commercial real estate sector remains particularly vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the ongoing recovery from the COVID-19 pandemic has heavily relied on stimulus payments to consumers.
Experts indicate that any banking challenges may arise in the forthcoming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that current provisions don’t fully reflect recent credit quality but rather banks’ expectations for the future.
In the near term, banks are predicting slower economic growth, an increased unemployment rate, and anticipated interest rate reductions later this year. This may signal a rise in delinquencies and defaults as 2023 concludes.
Citi’s CFO Mark Mason pointed out that warning signs predominantly affect lower-income consumers who have seen their savings diminish since the pandemic. He emphasized a discrepancy in financial health across different income brackets, noting that only the highest income quartile has retained more savings than they had in early 2019.
Despite the increasing concerns, Mulberry stresses that defaults are not currently rising to a level that signals an imminent consumer crisis. He highlighted a distinction between homeowners and renters during the pandemic, pointing out that homeowners benefitted from historically low fixed-rate loans while renters faced significant challenges.
With rents surging over 30% from 2019 to 2023 and grocery prices rising by 25%, renters unable to secure low rates are experiencing significant financial strain compared to those who bought homes.
The latest earnings reports from the banks indicate that the asset quality remains stable. Strong revenues and profits alongside resilient net interest income are promising signs for the banking sector’s ongoing health.
Mulberry remarked on the fundamental strength of the financial system while cautioning that prolonged high-interest rates could lead to further stress ahead.