As interest rates reach their highest levels in over 20 years and inflation continues to pressure consumers, major banks are bracing for potential risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions represent funds set aside by financial institutions to cover potential losses stemming from delinquent debts and other credit risks, particularly in commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s provision totaled $21.8 billion, significantly up from the previous quarter; and Wells Fargo recorded provisions of $1.24 billion.
The raised provisions indicate banks are preparing for a challenging economic environment, where both secured and unsecured loans could lead to greater losses. The New York Fed recently highlighted that U.S. household debt has climbed to $17.7 trillion, encompassing consumer loans, student debt, and mortgages.
With pandemic savings diminishing, the reliance on credit is rising, leading to increased credit card issuance and delinquency rates. In the first quarter of this year, total credit card balances reached $1.02 trillion, marking the second consecutive quarter where the total exceeded a trillion dollars, as reported by TransUnion. Additionally, the CRE sector remains vulnerable.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the financial state of consumers is still adjusting post-COVID, largely influenced by government stimulus measures.
Issues for banks are anticipated in the future, as noted by Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group. He explained that quarterly provisions reflect banks’ expectations for future credit quality rather than just past performance.
The banks are forecasting slower economic growth, higher unemployment rates, and potential interest rate cuts later this year. This outlook could result in more delinquencies and defaults toward the end of the year.
Citi’s chief financial officer, Mark Mason, pointed out that the concerns are particularly prevalent among lower-income consumers, whose savings have diminished since the pandemic.
Despite overall resilience in the U.S. consumer landscape, Mason indicated a significant disparity in financial behavior across different income levels and credit scores. Only the top income quartile has increased its savings since 2019, while consumers with lower credit scores are experiencing rising borrowing and decreasing payment rates due to heightened inflation and interest rates.
The Federal Reserve maintains interest rates at a 23-year high, waiting for inflation measures to stabilize before potentially reducing rates.
While banks are preparing for increased defaults, Mulberry suggests that current default rates do not indicate an impending consumer crisis. He is particularly attentive to the differences between homeowners and renters during this period of economic change. Homeowners benefited from locking in low fixed rates, while renters are facing significant cost increases.
From the latest earnings reports, analysts noted that asset quality appears stable. Resilient revenues, profits, and net interest income point to a banking sector that remains robust.
Mulberry expressed cautious optimism, noting the strength of the financial system but warning that sustained high interest rates could generate further stress.