As interest rates remain at their highest levels in over 20 years and inflation continues to pressure consumers, major banks are preparing for potential 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 are funds that financial institutions reserve to cover possible losses from credit risks, including unpaid debts and issues related to lending, especially in commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance reached $21.8 billion at the end of the quarter, more than tripling its reserves from the prior quarter, and Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are anticipating a riskier lending environment where both secured and unsecured loans could pose greater losses for some of the largest banks in the country. A recent analysis by the New York Fed showed that Americans currently owe a total of $17.7 trillion in consumer, student, and mortgage loans.
The issuance of credit cards, along with delinquency rates, is also on the rise as consumers deplete their pandemic-era savings and turn increasingly to credit. Outstanding credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where totals surpassed the trillion-dollar milestone, according to TransUnion. Additionally, the CRE sector remains vulnerable.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the lingering effects of the COVID-19 era, particularly in relation to banking and consumer health, are largely due to prior stimulus efforts directed at consumers.
Future challenges for banks may emerge soon. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, emphasized that the provisions seen in any quarter do not solely reflect credit quality from the last three months but instead represent banks’ expectations for future trends.
Narron noted that the current economic outlook suggests slowing growth, a rise in unemployment, and anticipated interest rate cuts in September and December. This could lead to increased delinquency and default rates as the year ends.
Citi CFO Mark Mason highlighted that the warning signs regarding credit performance are predominantly related to lower-income consumers who have experienced significant declines in savings since the pandemic began.
While overall consumer resilience in the U.S. remains, there is a noticeable disparity in behavior and performance across different income and credit score bands. Mason pointed out that only the highest income quartile has increased their savings since early 2019, with high-FICO score consumers driving spending growth and maintaining strong payment rates. In contrast, lower-FICO score customers are struggling more significantly under the weight of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, aiming for inflation to stabilize around the central bank’s 2% target before moving to cut rates.
Despite preparing for increased defaults later in the year, Mulberry noted that current default rates do not yet indicate a consumer crisis. He is particularly observing the experiences of homeowners versus renters during this period.
Although interest rates have risen significantly, homeowners have secured low fixed rates on their debts, which has insulated them from financial distress. In contrast, renters have not benefited from such opportunities and have faced a significant increase in costs, with rents soaring over 30% nationwide from 2019 to 2023, and grocery prices climbing 25%.
For now, the latest earnings reports suggest stability in asset quality. Narron remarked that there were no alarming new trends observed in the recent quarter. Robust revenues, profits, and resilient net interest income are positive signs for the banking sector’s health.
Mulberry concluded that there is still strength within the financial system, which is reassuring, but the ongoing high interest rates may lead to increasing pressure over time.