With interest rates reaching their highest levels in over 20 years and inflation putting pressure on consumers, major banks are bracing for potential risks in 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 reserve to cover potential losses from credit risk, such as delinquent debts and lending in sectors like commercial real estate.
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, more than tripling its previous quarter’s reserve, and Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier environment, where both secured and unsecured loans may lead to greater losses. A recent analysis by the New York Fed revealed that Americans collectively owe approximately $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards and delinquency rates are also on the rise as individuals exhaust 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 totals surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector remains particularly fragile.
“Even as we transition out of the COVID era, the stimulus provided to consumers has significantly influenced the banking sector and consumer health,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any issues for banks are likely to surface in the coming months.
“The provisions recorded in a given quarter do not necessarily reflect recent credit quality; rather, they indicate what banks anticipate for the future,” stated Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He noted a shift from a traditional system where growing loan defaults would trigger increased provisions to one where macroeconomic forecasts shape provisioning strategies.
In the short term, banks expect a slowdown in economic growth, higher unemployment rates, and two planned interest rate cuts later this year, which could lead to more delinquencies and defaults by year-end.
Citi’s chief financial officer, Mark Mason, indicated that rising credit risks are predominantly associated with lower-income consumers who have seen their savings deplete since the pandemic.
“While the U.S. consumer remains generally resilient, we observe a significant performance and behavioral divergence across income levels and credit scores,” Mason remarked in a recent call with analysts.
He noted that only the top income quartile has increased savings since early 2019, with customers scoring over 740 on the FICO scale driving spending growth and maintaining high payment rates. In contrast, lower-scoring consumers are experiencing significant reductions in payment rates and are borrowing more heavily due to the impact of high inflation and interest rates.
The Federal Reserve currently maintains interest rates at a 23-year high of 5.25-5.5%, holding off on cuts until inflation stabilizes closer to its 2% target.
While banks are preparing for wider defaults later in the year, current default rates do not yet indicate a consumer crisis, according to Mulberry. He highlights the difference between homeowners and renters during the pandemic era.
“Yes, interest rates have risen dramatically since then, but homeowners secured very low fixed rates on their debts, so they aren’t feeling as much financial pressure,” Mulberry explained. In contrast, renters, who did not benefit from those low rates, are now grappling with rent increases of over 30% nationwide between 2019 and 2023 and grocery costs rising by 25%.
For the time being, the latest earnings reports suggest “no new developments this quarter regarding asset quality,” Narron noted. In fact, strong revenue, profits, and stable net interest income are encouraging indicators of a healthy banking sector.
“There is notable strength in the banking industry that may not have been entirely anticipated, but it’s reassuring to see the financial system’s structure remain strong and sound at present,” Mulberry concluded. “However, we are closely monitoring the situation, as sustained high interest rates could lead to increased stress on the sector.”