With interest rates reaching their highest levels in over 20 years and inflation impacting consumers, major banks are bracing for increased risks associated with 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 banks set aside to cover potential losses from credit risks, including delinquent loans and those related to commercial real estate.
JPMorgan set aside $3.05 billion for credit losses in the second quarter; Bank of America allocated $1.5 billion; Citigroup’s total reached $21.8 billion, marking a significant tripling from the previous quarter; and Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier lending environment, where both secured and unsecured loans may present greater challenges. A recent analysis by the New York Fed highlighted that Americans currently owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, the issuance of credit cards and associated delinquency rates are rising as people deplete their pandemic savings and turn to credit for financial support. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total balances surpassed the trillion-dollar mark, according to TransUnion. The commercial real estate sector also remains under pressure.
“We’re still navigating the post-COVID landscape, particularly concerning banking and consumer health, which was significantly influenced by stimulus measures from the government,” noted Brian Mulberry, a portfolio manager at Zacks Investment Management.
However, the potential difficulties for banks are likely to manifest in the coming months.
“The provisions reported in any given quarter do not necessarily reflect the credit quality observed in the last three months; rather, they represent banks’ expectations for future trends,” said Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
He also pointed out a shift from a traditional model where rising loan defaults mandated increased provisions to a system where macroeconomic forecasts predominantly dictate provisioning strategies.
Looking ahead, banks anticipate slower economic growth, a rising unemployment rate, and potential interest rate cuts later this year in September and December. This could lead to more delinquencies and defaults as the year closes.
Citi’s CFO Mark Mason highlighted that these warning signs seem to be particularly evident among lower-income consumers, who have seen their savings diminish since the pandemic.
“While U.S. consumers remain resilient overall, we observe a diverging performance across different income and credit score groups,” Mason said during a recent analyst call.
He elaborated that only the highest-income quartile has managed to maintain more savings than they had at the start of 2019, with spending growth and high payment rates primarily driven by customers with FICO scores over 740. In contrast, those with lower credit scores are experiencing more significant drops in payment rates and increasingly relying on credit, facing heightened pressure from inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting a stabilization in inflation to approach its 2% target before implementing anticipated rate cuts.
Despite preparations for a rise in defaults later in the year, current data does not indicate a significant consumer crisis, according to Mulberry. He emphasizes the distinction between homeowners and renters during the pandemic.
“Rates have surged since then; however, homeowners have locked in very low fixed rates on their mortgages, which mitigates their financial pain. On the other hand, renters missed out on that opportunity,” Mulberry explained.
As housing prices have increased over 30% nationally from 2019 to 2023, and grocery costs have risen by 25%, renters—who didn’t benefit from stable rates—are facing more strain on their budgets.
At this time, the key insight from the recent earnings reports is that there are no new concerns regarding asset quality. Strong revenue, profits, and resilient net interest income are all encouraging signs for the banking sector’s health.
“There is still strength within the banking sector, and while this may not have been entirely unforeseen, it is reassuring to note that the financial system’s structure remains solid,” Mulberry remarked. “However, we are closely monitoring the situation, as sustained high-interest rates will inevitably increase stress on the system.”