As interest rates reach their highest levels in over 20 years and inflation continues to put pressure on consumers, major banks are preparing for increased risks related 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 are funds that banks set aside to cover potential losses from credit risks, such as delinquent or defaulted loans and commercial real estate (CRE) lending.
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, having more than tripled its reserves from the previous quarter. Wells Fargo had provisions totaling $1.24 billion.
This accumulation of reserves indicates that banks are preparing for a more challenging environment where both secured and unsecured loans could lead to larger losses for some of the country’s largest financial institutions. A recent study by the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
As pandemic-era savings dwindle, the issuance of credit cards and the rate of delinquencies are rising, as consumers increasingly rely on credit. Credit card balances surged to $1.02 trillion in the first quarter, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. Additionally, the commercial real estate sector remains in a vulnerable position.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, highlighted that the ramifications of the COVID-19 pandemic, particularly the extensive stimulus support to consumers, continue to affect the banking landscape.
Experts caution that challenges for banks may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, stated that the provisions reported in any quarter largely signify what banks anticipate for the future rather than reflecting credit quality from the past three months.
He noted a shift in the banking system’s approach, transitioning from a model where rising loan defaults directly increased provisions to one driven by macroeconomic forecasts. Currently, banks are predicting slowing economic growth, higher unemployment rates, and potential interest rate cuts in September and December, which could lead to more delinquencies and defaults as the year concludes.
Citigroup’s CFO Mark Mason pointed out that these concerns primarily affect lower-income consumers, who have seen their savings eroded since the pandemic began.
While there is an overall resilient U.S. consumer base, discrepancies in financial health exist across income levels. According to Mason, only consumers in the highest income bracket have maintained more savings than they had in early 2019. Customers with FICO scores above 740 are driving spending growth and consistently making payments, contrasting with lower FICO score consumers who are facing declining payment rates and increasing borrowing due to the impacts of inflation and elevated interest rates.
The Federal Reserve has kept interest rates between 5.25% and 5.5%, the highest level in 23 years, as it awaits stabilization in inflation closer to its 2% target before proceeding with anticipated rate cuts.
Despite preparations for potential defaults in the latter half of the year, Mulberry noted that current default rates do not suggest an imminent consumer crisis. He highlighted the distinction between homeowners who locked in low fixed mortgage rates during the pandemic and renters who missed this opportunity.
Renters have been particularly affected by a rise in national rent prices of over 30% from 2019 to 2023, alongside a 25% increase in grocery costs during the same timeframe. Those who were unable to secure lower rates are now feeling the strain on their monthly budgets.
On a positive note, the latest earnings reports showed no significant new concerns regarding asset quality. Strong revenues, profits, and stable net interest income are indicators of a healthy banking sector. Mulberry expressed reassurance in the robustness of the financial system but stressed the need for vigilance as high interest rates persist, which could lead to increased stress within the economy.