With interest rates at their highest in over 20 years and inflation persistently affecting consumers, major banks are bracing for increased risks linked to their lending practices.
In the second quarter, major financial institutions such as 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 banks allocate to cover potential losses from credit risks, including overdue debts and unsatisfactory loans, particularly in commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, more than tripling its reserves from the past quarter. Wells Fargo recorded provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging economic landscape, where both secured and unsecured loans could lead to greater losses. A recent report from the New York Fed highlighted that Americans owe a combined total of $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards, along with rising delinquency rates, is also on the upswing as consumers deplete their pandemic-era savings and turn 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. The commercial real estate sector remains vulnerable as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, pointed out, “We’re still emerging from the COVID era, especially regarding banking and consumer health, largely due to the stimulus provided to consumers.”
However, banks are likely to face challenges in the forthcoming months.
Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that the provisions set aside by banks do not merely reflect past credit quality but rather what banks anticipate will occur in the future. He added, “We’ve shifted from a historical model where rising loan defaults increased provisions to a framework where macroeconomic forecasts dictate provisioning.”
In the short term, banks are expecting slower economic growth, a climbing unemployment rate, and projections of two interest rate cuts later this year in September and December. This scenario could lead to an uptick in delinquencies and defaults as the year concludes.
Citi CFO Mark Mason indicated that these warning signs seem concentrated among lower-income consumers who have seen their savings diminish since the pandemic began. He remarked, “While we continue to see overall resilience in the U.S. consumer, there is a divergence in performance and behavior across different income levels.”
Mason observed that only the highest income quartile has more savings than pre-2019 levels, with high-FICO score customers driving spending growth and maintaining good payment rates. Conversely, consumers with lower FICO scores are facing significant drops in payment rates and are increasing their borrowing as they struggle with the impacts of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, as it awaits inflation metrics to stabilize closer to its 2% target before implementing anticipated rate cuts.
Despite banks preparing for a potential rise in defaults later in the year, current data does not suggest an immediate consumer crisis. Mulberry pointed out a crucial distinction between homeowners during the pandemic and renters: “Although rates have risen significantly since then, homeowners secured low fixed rates on their debts and are not feeling the pinch as much.”
For renters, the situation is starkly different. With national rent prices surging over 30% from 2019 to 2023 and grocery costs climbing 25% in that same period, those who were renting and did not benefit from low rates are feeling the most financial strain.
Ultimately, Narron concluded that the recent earnings report showed no new issues related to asset quality. Strong revenues, profits, and a robust net interest income are encouraging signs for the banking sector’s health.
Mulberry affirmed, “There is some strength in the banking sector that is reassuring and indicates that the foundations of the financial system remain solid. However, we are monitoring the situation closely, as prolonged high interest rates could lead to increased stress.”