With interest rates reaching over two-decade highs and inflation continuing to pressure 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 heightened their provisions for credit losses compared to the previous quarter. These provisions represent funds that banks set aside to cover potential losses from credit risks, including bad debts and lending, particularly concerning commercial real estate loans.
JPMorgan allocated $3.05 billion towards credit loss provisions in the second quarter; Bank of America reserved $1.5 billion; Citigroup’s allowance totaled $21.8 billion, more than tripling its reserves from the prior quarter; and Wells Fargo’s provisions stood at $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans could lead to greater losses. A recent analysis by the New York Fed highlighted that Americans collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Additionally, the issuance of credit cards and the corresponding delinquency rates are rising 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 consecutive quarter where totals exceeded one trillion dollars, according to TransUnion. The commercial real estate sector also remains under significant strain.
“We’re still emerging from the COVID era, especially regarding banking and consumer health, largely affected by the stimulus measures provided to consumers,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, challenges for banks are expected in the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, noted that the provisions reported in any quarter do not necessarily indicate the recent quality of credit but rather reflect banks’ expectations for future conditions.
“And it’s interesting because we’ve shifted from a historical approach where rising loan defaults would lead to increased provisions to a model where macroeconomic forecasts play a significant role in that provisioning,” he added.
In the short term, banks foresee slower economic growth, a higher unemployment rate, and two anticipated interest rate cuts later this year, which could result in more delinquencies and defaults by the end of the year.
Citigroup’s Chief Financial Officer Mark Mason pointed out that these warning signs primarily affect lower-income consumers who have seen their savings diminish post-pandemic.
“We still observe resilient overall behavior among U.S. consumers, but there is a noticeable divergence in performance across different income levels and credit scores,” Mason mentioned during an analyst call earlier this month.
Mason elaborated that only the highest income bracket has managed to save more than at the beginning of 2019, and consumers with higher credit scores are contributing to spending growth and maintaining high payment rates. In contrast, those with lower credit scores are experiencing detrimental drops in payment rates while accruing more debt, exacerbated by high inflation and interest rates.
The Federal Reserve has sustained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation in line with its 2% target before implementing the anticipated rate cuts.
Despite banks preparing for potential, broader defaults in the latter half of the year, defaults have not yet surged to a level indicative of a consumer crisis, according to Mulberry. He is monitoring the contrast between homeowners during the pandemic and renters.
“While interest rates have climbed significantly, homeowners locked in very low fixed-rate debts, so they aren’t feeling the pinch as much,” Mulberry remarked. “Renters, on the other hand, have not had similar opportunities.”
With rents surging over 30% nationally from 2019 to 2023 and grocery costs climbing 25% in the same period, renters without fixed rates are feeling financial strain the most, as their expenses soar relative to wage growth.
For now, the key insight from the latest earnings reports is that there were no alarming developments regarding asset quality. Strong revenues, robust profits, and resilient net interest income indicate the banking sector remains healthy.
“There’s a degree of strength in the banking sector that may not have been entirely unexpected, but it is reassuring to see that the financial system remains sound,” Mulberry concluded. “However, we will be monitoring the situation closely, as prolonged high interest rates can induce more stress.”