With interest rates reaching their highest levels in over two decades and inflation affecting consumers, major banks are bracing for increased risks linked to their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all raised their provisions for credit losses compared to the previous quarter. These provisions are funds that banks set aside to mitigate potential losses from credit risks, including defaults and bad debt associated with lending, particularly in commercial real estate.
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 rose to $21.8 billion, more than tripling its reserves from the previous quarter, and Wells Fargo recorded provisions totaling $1.24 billion.
This increase indicates that banks are preparing for a more challenging lending environment, in which both secured and unsecured loans may lead to higher losses. A recent report from the New York Federal Reserve revealed that American households hold a collective $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are climbing as consumers deplete their pandemic savings and turn increasingly to credit. In the first quarter of this year, credit card balances surpassed $1 trillion for the second consecutive quarter, based on data from TransUnion. The commercial real estate sector also remains in a vulnerable state.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the effects of the COVID-19 pandemic and the subsequent stimulus measures have greatly influenced consumer financial health.
However, banks are anticipating more issues in the future. Mark Narron, a senior director at Fitch Ratings, explained that quarterly provisions do not solely reflect recent credit quality but rather banks’ expectations for future performance.
According to Narron, banks expect a slowdown in economic growth, an uptick in unemployment, and two interest rate cuts in September and December. This situation could lead to more delinquencies and defaults as the year wraps up.
Citi’s chief financial officer, Mark Mason, pointed out that warning signs are particularly evident among lower-income consumers, whose savings have largely diminished 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,” Mason stated during a recent analyst call. He highlighted that only the highest income quartile has more savings than at the start of 2019, with those having high credit scores driving spending growth and maintaining strong payment rates. Conversely, customers with lower credit scores are experiencing significant declines in payment rates and are borrowing more due to high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation before implementing expected rate cuts.
Despite the banks’ preparations for increasing defaults in the latter part of the year, Mulberry believes defaults have not risen to levels indicating a consumer crisis. He is particularly monitoring the difference between pandemic-era homeowners and renters.
“Homeowners locked in very low fixed rates on their debt and are not feeling the pressure as much,” said Mulberry, contrasting their situation with renters who have faced soaring rental costs. Rent prices have surged by over 30% nationwide from 2019 to 2023, alongside a 25% increase in grocery costs.
Currently, the latest earnings reports reveal no significant new concerns regarding asset quality. Strong revenues, profits, and resilient net interest income suggest that the banking sector remains healthy.
“There’s some strength in the banking sector that wasn’t entirely expected, but it’s a relief to see that the structures of the financial system are still strong,” Mulberry concluded. However, he warned that prolonged high-interest rates could lead to more stress in the financial landscape.