With interest rates now at their highest levels in over two decades and inflation continuing to impact consumers, major banks are bracing for potential risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their credit loss provisions compared to the previous quarter. These provisions are funds that banks set aside to cover potential losses arising from credit risk, including defaults and bad debts related to loans like commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses; Bank of America allocated $1.5 billion; Citigroup’s allowance reached $21.8 billion—tripling its reserve build from the previous quarter; and Wells Fargo recorded provisions of $1.24 billion.
These provisions indicate that banks anticipate a challenging environment, where both secured and unsecured loans may lead to greater losses. A recent analysis by the New York Fed revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are climbing as individuals deplete their pandemic-era savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second straight quarter where the total exceeded the trillion-dollar threshold, as noted by TransUnion. Meanwhile, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, highlighted that the ongoing effects of the COVID-19 pandemic, along with the consumer stimulus measures, continue to shape the banking landscape.
However, any forthcoming challenges for banks may emerge in the months to come. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported in any given quarter do not solely reflect past credit quality but rather what banks project will occur in the future.
He noted that the financial landscape has shifted from a model where increasing defaults prompted higher provisions to one where macroeconomic forecasts significantly influence provisioning strategies.
In the short term, banks anticipate slower economic growth, a rise in unemployment rates, and potential interest rate cuts later this year, which could contribute to more delinquencies and defaults by year-end.
Citigroup’s CFO, Mark Mason, pointed out that the warning signs seem most pronounced among lower-income consumers, who have seen their savings diminish in recent years since the pandemic.
“While the overall U.S. consumer remains resilient, we observe distinct differences in performance based on income and credit scores,” Mason indicated during a call with analysts. He remarked that only the highest income quartile has managed to increase their savings since early 2019, and those with higher FICO scores are primarily driving spending growth and maintaining their payment rates. In contrast, lower FICO customers face sharper declines in payment rates and are borrowing more due to the pressures of high inflation and interest rates.
The Federal Reserve is maintaining interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation measures toward its 2% target before enacting anticipated rate cuts.
Despite banks gearing up for increased defaults later this year, Mulberry contended that current default rates do not indicate an imminent consumer crisis. He is particularly focused on the divide between homeowners and renters.
While interest rates have significantly increased, homeowners who secured low fixed rates during the pandemic are largely protected from rising costs, unlike renters who have faced surging rent prices.
With rents rising over 30% nationally from 2019 to 2023 and grocery prices climbing 25% in the same timeframe, renters struggling with costs that outpace wage growth are the ones facing the most financial strain.
For now, the key takeaway from the latest earnings reports is that there have been no significant negative shifts in asset quality. Strong revenues, profits, and solid net interest income demonstrate that the banking sector remains relatively healthy.
“There is some resilience in the banking sector that wasn’t completely unexpected, but it is reassuring to confirm that the financial system is still robust,” Mulberry stated. “However, we are closely monitoring the situation, as prolonged high-interest rates may lead to increased stress.”