As interest rates reach their highest levels in over 20 years and inflation continues to impact consumers, major banks are bracing for potential risks linked to 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 financial institutions reserve to mitigate any anticipated losses from credit risks, such as defaults on loans, including those for commercial real estate.
Specifically, JPMorgan set aside $3.05 billion for credit losses in the second quarter; Bank of America allocated $1.5 billion; Citigroup’s allowance reached $21.8 billion by the quarter’s end, more than tripling its previous credit reserve; and Wells Fargo had provisions totaling $1.24 billion.
The increased provisions signal that banks are preparing for a riskier environment, where both secured and unsecured loans could lead to more significant losses. A recent analysis by the New York Federal Reserve revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also climbing as pandemic savings diminish and consumers turn increasingly to credit. Credit card debt reached $1.02 trillion in the first quarter, marking the second consecutive quarter in which total balances surpassed the trillion-dollar threshold, as reported by TransUnion. Additionally, the commercial real estate sector remains precarious.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking landscape differs significantly from previous years, primarily due to the economic effects of the COVID-19 pandemic and the various stimulus measures that were provided to consumers.
Looking ahead, issues for banks are expected to manifest in the coming months. “The provisions seen in any given quarter don’t necessarily reflect the credit quality of the past three months but rather what banks anticipate for the future,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He highlighted a shift in the banking system towards a macroeconomic forecast-driven approach to provisioning, contrasting with the previous method where rising bad loans directly triggered increased provisions.
In the near future, banks are predicting a slowdown in economic growth, a rise in unemployment rates, and potentially two interest rate cuts planned for September and December. This scenario could result in more delinquencies and defaults by the end of the year.
Mark Mason, Citi’s chief financial officer, observed that warning signs seem to be concentrated among lower-income consumers, who have experienced a significant decline in savings since the pandemic.
“While the overall U.S. consumer remains resilient, we see significant performance discrepancies across different income levels and credit scores,” Mason remarked during a recent analyst call. He noted that only the highest income quartile has maintained a higher level of savings than they had in early 2019, with those in the over-740 FICO score category driving spending growth and maintaining solid payment rates. In contrast, consumers with lower FICO scores are facing increased borrowing and a decline in payment rates due to the effects of high inflation and rising interest rates.
The Federal Reserve has held interest rates steady at a 23-year peak of 5.25-5.5%, awaiting stabilization in inflation rates toward its 2% target prior to implementing the anticipated rate cuts.
Despite cautionary measures being taken by banks in light of possible defaults, Mulberry notes that defaults have not yet escalated to levels indicative of a consumer crisis. He is particularly observant of the distinction between homeowners and renters during the pandemic.
“While interest rates have surged, homeowners benefited from low fixed-rate loans, allowing them to avoid substantial financial strain,” Mulberry said. “Conversely, those who were renting missed out on that opportunity.”
With rental costs rising over 30% nationally and grocery prices increasing by 25% from 2019 to 2023, renters who didn’t secure low rates and are now facing exorbitant rental prices that have not kept pace with wage growth are experiencing pronounced financial pressure.
For the time being, the recent earnings reports reveal “no new developments in asset quality,” according to Narron. Positive indicators, such as strong revenues and profits along with resilient net interest income, reflect a continuous health in the banking sector.
“There are signs of strength within the banking sector that may not have been entirely expected, but it’s reassuring to see that the foundations of the financial system remain robust,” Mulberry concluded. “However, we must keep a close watch, as prolonged high interest rates will induce more stress.”