With interest rates reaching their highest levels in over two decades and inflation continuing to pressure consumers, major banks are bracing for potential challenges 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 represent funds that financial institutions reserve to cover possible losses from credit risks, which include delinquent debts and various loans, such as those for commercial real estate (CRE).
JPMorgan allocated $3.05 billion to provisions for credit losses; Bank of America set aside $1.5 billion; Citigroup’s total for credit loss allowances was $21.8 billion at the end of the quarter, significantly increasing its reserves; and Wells Fargo provisioned $1.24 billion.
These increased reserves indicate that banks are preparing for a possibly riskier lending environment where both secured and unsecured loans may lead to greater losses. A recent report from the New York Fed indicated that Americans are burdened with a collective debt of $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are climbing as many individuals deplete their pandemic savings and turn increasingly to credit. TransUnion reported that credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar milestone. The situation in commercial real estate remains concerning as well.
“We are still navigating the aftermath of the COVID era, particularly regarding banking and consumer health, largely due to the stimulus provided during that time,” said Brian Mulberry, a portfolio manager at Zacks Investment Management.
However, any potential issues for banks may emerge over the coming months.
“The provisions reported in any given quarter don’t necessarily indicate recent credit quality; instead, they reflect banks’ expectations for the future,” noted Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
“It’s interesting because we’ve seen a shift from a historical model where rising loan defaults would lead to increased provisions, to a new model where macroeconomic forecasts dictate provisioning strategies,” he added.
Looking ahead, banks anticipate slower economic growth, a rise in unemployment, and two interest rate reductions later this year, likely in September and December, which could lead to more delinquencies and defaults as the year progresses.
Citigroup CFO Mark Mason pointed out that these warning signs seem to be more pronounced among lower-income consumers, who have seen their savings erode since the pandemic began.
“While we still observe resilient overall performance among U.S. consumers, there is a noticeable disparity based on income and credit scores,” Mason explained during a recent analyst conference call. “Only those in the highest income quartile have managed to increase their savings since early 2019, while customers with high FICO scores are driving spending growth and maintaining elevated payment rates. In contrast, lower FICO score customers are experiencing considerable drops in payment rates and are borrowing more due to the pressures of high inflation and interest rates.”
The Federal Reserve has maintained interest rates at a 23-year high between 5.25% and 5.5%, awaiting stabilization in inflation toward its 2% target before implementing any anticipated rate cuts.
Despite banks preparing for more widespread defaults in the latter part of the year, current trends do not yet indicate a crisis among consumers, according to Mulberry. He is closely monitoring the differences between homeowners and renters from the pandemic.
“Although interest rates have risen considerably, homeowners generally secured low fixed rates on their debts during that time, which has shielded them from immediate pain,” Mulberry stated. “In contrast, renters did not have the same opportunities.”
With rents increasing over 30% nationwide from 2019 to 2023 and grocery prices rising 25% in the same timeframe, renters unable to secure low rates are experiencing significant strain on their finances as rental expenses outpace wage growth.
Overall, the latest earnings reports reveal “nothing particularly new regarding asset quality,” according to Narron. In fact, strong revenue, profits, and robust net interest income are positive signs for the banking sector’s health.
“There remains a degree of strength in the banking sector that, while perhaps not entirely unexpected, is certainly reassuring. The foundations of our financial system appear to be stable and sound at this moment,” Mulberry said. “However, the longer high interest rates persist, the more stress they could impose.”