With interest rates reaching their highest levels in over 20 years and inflation continuing to impact consumers, major banks are gearing up to tackle 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 debts and commercial real estate loans.
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, reflecting a significant increase from the previous quarter, and Wells Fargo provisioned $1.24 billion.
These provisions indicate that banks are bracing for a riskier lending environment, where both secured and unsecured loans may lead to greater losses. A recent analysis of household debt by the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as consumers exhaust pandemic-era savings and increasingly rely on credit. Credit card balances surpassed $1.02 trillion in the first quarter, marking the second consecutive quarter above the trillion-dollar threshold, according to TransUnion. Additionally, the commercial real estate sector remains vulnerable.
“We’re still transitioning out of the COVID era, especially in terms of banking and consumer health, largely due to the stimulus efforts directed at consumers,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, experts suggest any banking issues are likely to emerge in the coming months.
“The provisions noted in any quarter do not directly correlate to the credit quality experienced over the past three months, as they reflect banks’ expectations for the future,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
He added, “Interestingly, we’ve shifted from a traditional model where increasing bad loans prompted higher provisions, to one where macroeconomic forecasts greatly influence provisioning.”
In the short term, banks anticipate slowing economic growth, an increase in unemployment, and two interest rate cuts expected later this year in September and December, which may lead to more delinquencies and defaults by year-end.
Citi’s chief financial officer Mark Mason highlighted that these warning signs are particularly apparent among lower-income consumers, who have seen their savings diminish since the pandemic.
“While the overall U.S. consumer remains resilient, there is a noticeable divergence in performance and behavior across different income levels and credit scores,” Mason indicated during a call with analysts.
He noted that only the highest income quartile has retained more savings than at the start of 2019, and consumers with FICO scores over 740 are driving spending growth while maintaining high payment rates. In contrast, those in lower FICO categories are experiencing sharper declines in payment rates and increasing borrowing, facing significant challenges from high inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation to meet its 2% target before implementing anticipated rate cuts.
Despite banks preparing for more defaults later in the year, Mulberry expressed that default rates currently do not indicate an imminent consumer crisis. He is particularly observing the distinction between those who owned homes during the pandemic versus renters.
“While interest rates have significantly increased, homeowners had the advantage of locking in low fixed rates, so they are not feeling the financial strain as acutely,” Mulberry explained. “Renters, who missed that opportunity, are now facing the brunt of rising rental prices.”
With rental costs rising over 30% nationally between 2019 and 2023 and grocery prices increasing by 25% in the same timeframe, renters have been hit hardest as their rental expenses outpace wage growth, adding pressure to their monthly budgets.
Currently, the major takeaway from the banks’ latest earnings reports is that there are no significant new issues regarding asset quality. In fact, robust revenues, profits, and stable net interest income suggest a healthy banking sector.
“There’s certainly some strength in the banking sector that might not have been entirely anticipated, but it’s reassuring to see that the foundations of the financial system remain strong and solid at this moment,” Mulberry emphasized. “However, the longer interest rates remain elevated, the more strain will likely develop.”