With interest rates hitting their highest levels in over two decades and inflation continuing to pressure consumers, major banks are preparing for increased risks linked to their lending practices.
In the second quarter of the year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all raised their provisions for credit losses compared to the previous quarter. These provisions represent the funds that financial institutions earmark to cover potential losses from credit risks such as bad debt and delinquent loans, including those related to commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter, while Bank of America reserved $1.5 billion. Citigroup’s allowance topped $21.8 billion at the end of the quarter, significantly higher than the previous quarter’s reserves, and Wells Fargo set aside $1.24 billion.
These provisions indicate that banks are preparing for a more precarious lending environment, where both secured and unsecured loans might result in greater losses. A recent analysis by the New York Fed highlighted that American households collectively owe about $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards is rising alongside increasing delinquency rates as consumers deplete their pandemic-era savings and become increasingly dependent on credit. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where the total exceeded the trillion-dollar threshold, according to TransUnion. Additionally, the commercial real estate sector is facing challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked on the ongoing economic recovery from the COVID-19 pandemic, emphasizing that consumer health was initially bolstered by various stimulus measures.
However, any challenges facing banks may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, noted that the provisions reported in any quarter reflect banks’ future expectations rather than just recent credit quality.
Narron also pointed out a shift from the traditional approach of increasing provisions in response to rising loan defaults to a new system where macroeconomic forecasts primarily shape credit provisioning.
In the short term, banks anticipate slower economic growth, higher unemployment rates, and possible interest rate cuts later this year, which could lead to increased delinquencies and defaults by year’s end.
Citigroup’s CFO Mark Mason highlighted concerns primarily affecting low-income consumers, who have seen their savings decrease since the pandemic. He noted that while the overall U.S. consumer remains resilient, performance varies significantly across different income levels and credit scores.
Only the top income quartile has maintained higher savings compared to 2019, and it is the consumers with high credit scores who are responsible for spending growth and keeping up with payments. In contrast, lower credit score customers are experiencing increased borrowing and declining payment rates, significantly affected by inflation and rising interest rates.
The Federal Reserve has sustained interest rates at a 23-year peak of 5.25-5.5%, pending stabilization of inflation toward the central bank’s target of 2% before implementing anticipated rate cuts.
Despite banks gearing up for more defaults in the latter half of the year, current default rates do not point to a widespread consumer crisis, according to Mulberry. He is particularly observing the distinction between those who owned homes during the pandemic and renters.
Mulberry noted that homeowners locked in low fixed rates despite the rise in interest rates and thus are not feeling as much financial strain. Meanwhile, renters have faced significant challenges, with rents rising over 30% nationwide from 2019 to 2023, outpacing wage growth and contributing to increased financial stress.
For the time being, analysts pointed out that the latest earnings report showed no new concerns regarding asset quality. Instead, positive indicators such as strong revenues, profits, and resilient net interest income suggest a robust banking sector.
Mulberry concluded that while certain strengths in the banking sector were expected, it’s reassuring to see the financial system maintaining its strength and stability. However, he emphasized that prolonged high-interest rates would inevitably lead to more stress on consumers and banks alike.