As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for potential risks stemming from 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 the funds that financial institutions allocate to mitigate potential losses related to credit risk, which includes overdue or defaulted debts and various types of lending, notably commercial real estate (CRE) 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 for credit losses reached $21.8 billion at the end of the quarter, significantly more than its previous reserves. Wells Fargo reported provisions of $1.24 billion.
These increased provisions indicate that banks are preparing for a more challenging environment where both secured and unsecured loans could lead to greater losses for some of the largest financial institutions in the country. A recent examination of household debt by the New York Federal Reserve revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise as consumers deplete their savings accumulated during the pandemic and increasingly rely on credit. Credit card balances topped $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total balances have exceeded a trillion dollars, according to TransUnion. Additionally, CRE remains in a vulnerable position.
“We are still emerging from the COVID era, particularly in relation to banking and consumer health, which were heavily influenced by the stimulus measures implemented,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any challenges for banks are anticipated in the coming months.
“The provisions recorded in any quarter do not necessarily reflect the quality of credit for the preceding three months; instead, they reflect banks’ expectations of future developments,” remarked Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
“We have transitioned from a system where provisions increased as loans began to default, to one where macroeconomic forecasts primarily drive provisioning,” he added.
In the short term, banks project slowing economic growth, rising unemployment, and two expected interest rate cuts later this year, possibly in September and December, which could lead to increased delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, noted concerning trends appear to be concentrated among lower-income consumers, who have experienced a decline in savings since the pandemic.
“While we continue to observe an overall resilient U.S. consumer market, there is a noticeable disparity in performance and behavior across different income and FICO score bands,” Mason conveyed during a recent call with analysts.
He added, “Among our consumer clients, only the highest income quartile has maintained more savings than at the start of 2019. It is primarily high-FICO score customers who are driving spending growth and ensuring high payment rates, while those with lower FICO scores are facing sharper declines in payment rates and increasing their borrowing due to high inflation and interest rates.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation metrics toward its 2% target before proceeding with anticipated rate cuts.
Despite banks preparing for higher rates of defaults later this year, default rates are not yet escalating to a level indicative of a consumer crisis, according to Mulberry. He is currently monitoring the differences between those who owned homes during the pandemic and renters.
“Yes, rates have risen significantly since then, but homeowners secured very low fixed rates on their debt, so they aren’t feeling the strain as much. Those renting during that period missed that opportunity,” Mulberry explained.
With rents rising over 30% nationwide from 2019 to 2023 and grocery prices increasing by 25% in the same timeframe, renters who could not lock in low rates are experiencing the most financial pressure as their rental costs outpace wage growth.
Overall, the latest earnings reports indicate that “there was nothing new this quarter in terms of asset quality,” according to Narron. In fact, strong revenues, profits, and resilient net interest income signal a still-robust banking sector.
“There is a degree of strength in the banking sector that was not entirely unexpected, but it is reassuring to see that the financial system remains fundamentally strong and sound at this moment,” Mulberry remarked. “Still, we are monitoring the situation closely, as the prolonged high interest rates will likely introduce more stress.”