As interest rates remain at their highest level in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks in their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all boosted their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks allocate to cover potential losses arising from credit risks, which include bad debt and lending to sectors like commercial real estate.
JPMorgan increased its provision for credit losses to $3.05 billion in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the quarter’s end, more than tripling its reserve build from the previous quarter, and Wells Fargo’s provisions amounted to $1.24 billion.
The increase in reserves indicates that banks are preparing for a more challenging environment, where both secured and unsecured loans may lead to larger losses for these financial institutions. A recent study by the New York Federal Reserve revealed that Americans carry a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Furthermore, credit card issuance and delinquency rates are on the rise as consumers deplete their pandemic-era savings and turn increasingly to credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances exceeded the trillion-dollar threshold, according to TransUnion. Meanwhile, commercial real estate remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the aftermath of COVID-19 is influencing consumer finances, particularly regarding the stimulus funds that were distributed during that time.
Problems for banks may arise in the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, explained that the provisions recorded in any given quarter do not solely reflect past credit quality but rather indicate what banks anticipate for the future.
Currently, banks are forecasting slower economic growth, higher unemployment rates, and two rate cuts expected in September and December, according to Narron. This could lead to more delinquencies and defaults as the year comes to a close.
Citi’s chief financial officer, Mark Mason, emphasized that these warning signs appear to be particularly concerning among lower-income consumers, who have seen their savings diminish since the pandemic began.
Despite reports of a resilient overall U.S. consumer, Mason observed variations in performance across different income levels. He highlighted that only the highest income quartile has more savings now compared to early 2019. Those with FICO scores above 740 are driving spending growth and maintaining high payment rates, while lower FICO band customers are experiencing significant declines in payment rates and borrowing more, as they are adversely affected by high inflation and interest rates.
The Federal Reserve has held interest rates steady at a range of 5.25% to 5.5%, awaiting stabilization in inflation measures to meet its 2% target before implementing anticipated rate cuts.
At this point, even as banks prepare for potential defaults later in the year, defaults have not yet surged to a level suggestive of a consumer crisis, according to Mulberry. He is particularly monitoring the differences between homeowners and renters from the pandemic period.
He noted that while interest rates have risen significantly, many homeowners secured low fixed rates on their mortgages, shielding them from immediate financial pain, unlike renters who lack that security.
With rents increasing over 30% nationwide from 2019 to 2023, and grocery prices rising by 25% during the same period, renters are feeling the financial strain more acutely as their wages fail to keep pace with these rising costs.
For now, the key takeaway from the latest earnings reports is that there were no significant changes in asset quality this quarter. Strong revenues, profits, and resilient net interest income suggest that the banking sector remains robust.
Mulberry remarked, “There’s some strength in the banking sector that I think was a bit of a relief to see,” noting that the foundations of the financial system are still strong as long as interest rates remain elevated. However, he cautioned that prolonged high interest rates could lead to increased stress on consumers and banks alike.