With interest rates reaching their highest levels in over 20 years and inflation putting pressure on consumers, major banks are bracing 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, including unpaid debts and lending, particularly in commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s credit loss allowance reached $21.8 billion by the end of the quarter, more than tripling its provision from the prior quarter. Meanwhile, Wells Fargo’s provisions amounted to $1.24 billion.
These increased provisions indicate that banks are preparing for a more precarious financial environment, where both secured and unsecured loans may lead to greater losses for some of the nation’s largest financial institutions. A recent analysis by the New York Fed revealed that Americans are now burdened with a collective $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as consumers deplete their pandemic-era savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter in which total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. The CRE sector remains similarly vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the ongoing impact of the COVID-19 pandemic on consumer health and banking: “We’re still coming out of this COVID era, and mainly when it comes to banking and the health of the consumer, it was all of the stimulus that was deployed to the consumer.”
However, experts caution that any issues for banks may arise in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that the provisions reflected by banks do not directly correspond to credit quality in the past three months; rather, they are based on future expectations.
Narron explained that the banking sector has transitioned from a period where increasing loan defaults indicated higher provisions to one where macroeconomic forecasts predominantly drive these provisions.
Looking ahead, banks are predicting slower economic growth, a rise in unemployment, and two anticipated interest rate cuts in September and December. These factors may contribute to a rise in delinquencies and defaults as the year progresses.
Citi’s CFO Mark Mason observed that the most significant concerns appear concentrated among lower-income consumers, who have experienced a decline in their savings since the pandemic. “While we continue to see an overall resilient U.S. consumer, we also continue to see a divergence in performance and behavior across FICO and income bands,” he stated.
Mason added that only the highest income quartile has more savings now than at the beginning of 2019 and that customers with FICO scores above 740 are driving spending growth with consistent payment rates. In contrast, lower FICO score customers are experiencing a sharp decline in payment rates while borrowing more due to the heightened impact of inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it awaits stabilization in inflation measures towards its 2% target before implementing the expected rate cuts.
Despite banks bracing for potential defaults later this year, Mulberry points out that defaults have not yet escalated to a level indicating a consumer crisis. He is observing the distinction between homeowners during the pandemic and renters, noting that while interest rates have risen significantly, homeowners have secured low fixed rates on their debt and are not feeling the financial strain as acutely.
In contrast, renters face significant challenges, with nationwide rents increasing by more than 30% from 2019 to 2023 and grocery prices rising by 25% in the same period. Renters who missed the opportunity to lock in low rates are experiencing the greatest financial pressure on their monthly budgets.
For now, the key takeaway from the latest earnings reports is that “there was nothing new this quarter in terms of asset quality,” according to Narron. Strong revenues, profits, and robust net interest income continue to signal a healthy banking sector.
Mulberry remarked, “There’s some strength in the banking sector that I don’t know was totally unexpected, but I think it’s certainly a relief to say that the structures of the financial system are still very strong and sound at this point in time. However, we are watching closely; the longer interest rates stay at such high levels, the more stress it causes.”