As interest rates remain at their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for increased risks in 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 manage potential losses from credit risks, including delinquent loans and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, more than triple its previous quarter’s reserve, and Wells Fargo had provisions of $1.24 billion.
These provisions indicate that banks are preparing for a potentially riskier lending climate, where both secured and unsecured loans could result in significant losses. A recent analysis by the New York Fed found Americans owe a staggering $17.7 trillion across various consumer loans, student loans, and mortgages.
Moreover, credit card issuance and delinquency rates are increasing as consumers exhaust their savings from the pandemic, relying more on credit. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter that total balances surpassed the trillion-dollar mark, as reported by TransUnion. The commercial real estate sector also remains vulnerable.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted the ongoing effects of the COVID era on consumer finance, especially considering the stimulus funds that were previously injected into the economy.
However, potential issues for the banks may arise in the future. Mark Narron, a senior director at Fitch Ratings, emphasized that the provisions seen at any given quarter reflect banks’ expectations rather than the actual credit quality from the past three months.
Narron explained that the shift has moved from a historical perspective where rising delinquency rates would trigger higher provisions, to a system where macroeconomic forecasts drive those provisions.
Looking ahead, banks anticipate slower economic growth, increased unemployment, and two expected interest rate cuts later this year, which could lead to more delinquencies and defaults by year-end.
Citigroup’s CFO Mark Mason highlighted that the risks seem concentrated among lower-income consumers who have depleted their savings since the pandemic. He noted a stark contrast in financial health across different income levels. Only the highest income quartile has more savings now than in early 2019, with higher FICO score customers maintaining strong spending and payment rates, while those in lower FICO bands are facing significant declines in payment rates and are borrowing more due to the pressures of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it waits for inflation to stabilize around its target of 2% before implementing anticipated rate cuts.
Despite banks preparing for potential increases in defaults in the latter part of the year, Mulberry indicated that defaults have not yet surged to a level indicating a consumer crisis. He noted the distinction between homeowners who secured low fixed rates during the pandemic and renters who missed those opportunities.
With rents rising over 30% nationally from 2019 to 2023, and grocery costs increasing by 25%, renters are facing the most financial strain as their expenses outpace wage growth.
Ultimately, the key takeaway from the latest earnings reports is that there have been no significant changes in asset quality, according to Narron. Strong revenues and profits, coupled with resilient net interest income, suggest the banking sector remains robust.
Mulberry concluded that while there is notable strength within the banking system, sustained high interest rates could introduce more stress over time.