As interest rates reach their highest levels in over two decades and inflation continues to affect consumers, major banks are preparing for potential risks related to 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 are funds set aside by financial institutions to cover potential losses stemming from credit risks, which may include delinquent payments and bad debts, particularly in areas like commercial real estate loans.
JPMorgan increased its credit loss provisions to $3.05 billion this quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses rose to $21.8 billion by the end of the quarter, tripling its reserve from the previous quarter, and Wells Fargo earmarked $1.24 billion.
These increases reflect banks’ preparations for a more challenging environment, with both secured and unsecured loans potentially leading to larger losses. A recent report from the New York Fed highlighted that American households carry a combined debt of $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also increasing as Americans dip into their pandemic savings and rely more heavily on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where the total exceeded the trillion-dollar milestone, as reported by TransUnion. Furthermore, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, stated that the banking sector’s health is still recovering from the COVID-19 era, significantly influenced by the financial stimulus provided to consumers.
However, analysts believe that any significant issues for banks are likely to emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that the provisions reported each quarter do not necessarily indicate recent credit quality but rather reflect banks’ expectations for future developments.
He explained that historically, banks increased provisions when loan performance deteriorated, whereas now, macroeconomic forecasts largely dictate these provisions.
Banks foresee slowing economic growth, rising unemployment, and potentially two interest rate cuts later this year, which could lead to increased delinquencies and defaults as the year concludes.
Citi CFO Mark Mason highlighted that the emerging challenges are particularly pronounced among lower-income consumers, whose financial situations have worsened since the pandemic.
While the overall U.S. consumer base appears resilient, there remains a divide in performance based on income and credit scores. Mason noted that only the top income quartile has retained more savings than before 2019, while those with lower credit scores are experiencing declines in payment rates as they feel more pressure from high inflation and interest rates.
The Federal Reserve has maintained interest rates at a significant high of 5.25%-5.5% while awaiting signs of inflation stabilizing closer to its 2% target before considering any anticipated rate cuts.
Despite banks preparing for potential defaults as the year progresses, there are currently no signs pointing to a consumer crisis, according to Mulberry. He indicated that while interest rates have risen significantly, homeowners have largely benefited from low fixed mortgage rates secured during the pandemic, whereas renters are facing more financial strain.
With rental prices soaring over 30% nationwide from 2019 to 2023 and grocery costs increasing by 25% during the same period, renters, lacking the opportunity to secure lower rates, are experiencing the greatest financial stress.
In conclusion, analysts have observed no new issues in asset quality during the latest earnings round. Strong revenues, profits, and resilient net interest income are indicative of a robust banking sector. Observations suggest that while the banking system remains strong, prolonged high interest rates will continue to exert pressure on financial stability.