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.
During the second quarter, prominent banks including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions are essential reserves set aside to mitigate potential losses arising from credit risks, such as delinquent payments and bad debt associated with lending activities, including commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance reached $21.8 billion at the end of the quarter, more than tripling the increase from the previous quarter, and Wells Fargo established provisions of $1.24 billion. These reserves indicate that banks are preparing for a more challenging economic environment, as rising secured and unsecured loans may result in significant losses for some of the largest financial institutions. Analysis from the New York Fed reveals that American households have accumulated $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card usage and delinquency rates are climbing as individuals deplete their savings accrued during the pandemic and increasingly rely on credit. According to TransUnion, credit card balances totalled $1.02 trillion in the first quarter of this year, marking the second consecutive quarter with balances exceeding a trillion dollars. The commercial real estate sector also faces uncertainties.
“We’re still navigating the aftermath of the COVID era, particularly regarding banking and consumer health, influenced heavily by the stimulus deployed to consumers,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Challenges for the banks may arise in the coming months. “The provisions set aside each quarter don’t necessarily reflect recent credit quality; rather, they indicate banks’ expectations for the future,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He pointed out that the banking sector has transitioned from a system where increasing loan defaults would prompt higher provisions to one where macroeconomic forecasts drive provisioning strategies.
Looking ahead, banks are anticipating a slowdown in economic growth, a rise in unemployment, and two potential interest rate cuts planned for September and December, which could result in increased delinquencies and defaults by the end of the year.
Citi’s chief financial officer, Mark Mason, remarked that these warning signs are concentrated among lower-income consumers, who have seen their savings diminish significantly since the pandemic began. “While the overall U.S. consumer remains resilient, we observe a divergence in behavior and performance based on income and credit scores,” Mason noted during an analyst call.
He added, “Only consumers in the highest income quartile have more savings than they did in early 2019, with those having a FICO score above 740 driving spending growth and maintaining high payment rates. Conversely, lower FICO score consumers are experiencing a steep decline in payment rates and increasing borrowing needs, impacted heavily by sustained high inflation and interest rates.”
The Federal Reserve has maintained interest rates at their current range of 5.25%-5.5% as they monitor inflation trends, aiming for stabilization towards their 2% target before implementing expected rate cuts.
Despite banks preparing for possible defaults later this year, Mulberry notes that current default rates do not yet indicate a consumer crisis. He highlights the distinction between homeowners and renters during the pandemic. “Homeowners locked in very low fixed rates, so they aren’t feeling the current strain as renters are. Rent prices have surged more than 30% nationwide since 2019, while groceries have risen 25%, putting significant pressure on renters who are now facing increased costs that have outpaced wage growth.”
Currently, the overall outlook from this quarter’s earnings report indicates no significant new issues related to asset quality. There are strong revenues, profits, and resilient net interest income, signaling a robust banking sector.
“There’s strength in the banking system that was perhaps not entirely surprising, but it does provide reassurance about the current stability of financial structures,” remarked Mulberry. However, he acknowledged that prolonged high interest rates could lead to more stress on the banking industry.