With interest rates at their highest in over 20 years and inflation continuing to pressure consumers, major banks are preparing for potential risks related to 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 cover possible losses due to credit risks, including defaults on loans.
Specifically, JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup reported an allowance for credit losses totaling $21.8 billion, which more than tripled its previous quarter’s provision, and Wells Fargo had provisions amounting to $1.24 billion.
These reserve increases indicate that the banks are preparing for a potentially riskier lending environment, with both secured and unsecured loans likely to lead to more significant losses. A recent analysis of household debt by the New York Federal Reserve revealed that Americans now carry a collective debt of $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise as individuals deplete their pandemic savings and increasingly depend on credit. The total outstanding credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where totals surpassed the trillion-dollar threshold, according to TransUnion. Additionally, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, stated, “We’re still coming out of this COVID era, and when it comes to banking and consumer health, much of it was driven by the stimulus that was provided.”
However, challenges for the banks may unfold in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that the provisions reported in any given quarter don’t necessarily represent credit quality over the last three months, but rather reflect banks’ expectations for future conditions.
“As we look ahead, we’ve transitioned from a historical system where deteriorating loan performance would prompt increased provisions to one where macroeconomic forecasts now significantly influence provisioning levels,” he explained.
In the short term, banks are forecasting an economic slowdown, rising unemployment rates, and anticipated interest rate cuts in September and December. This may result in increased delinquencies and defaults as the year progresses.
Citi’s chief financial officer Mark Mason highlighted that these warning signs are primarily apparent among lower-income consumers, who have experienced a decline in savings since the pandemic’s onset. “While the overall U.S. consumer remains resilient, there is a noticeable divergence in behavior based on income and credit scores,” he remarked.
Mason pointed out that only consumers in the highest income quartile have managed to maintain or grow their savings since early 2019. Consumers with credit scores over 740 are driving spending growth and maintaining high payment rates, while those in lower credit bands are struggling with higher payment defaults and an increased reliance on credit due to inflation and elevated interest rates.
Despite the banks’ preparations for default rates rising in the latter half of the year, Mulberry indicated that defaults are not yet increasing at levels that suggest a consumer crisis. He is particularly attentive to the differences between homeowners who were able to secure low fixed mortgage rates and renters who have faced significant rent increases.
With rents rising by more than 30% nationwide between 2019 and 2023 and grocery costs climbing 25% in the same timeframe, renters, who missed the opportunity to lock in lower rates, are under significant financial strain.
Currently, the main takeaway from the latest earnings reports is a lack of alarming news regarding asset quality. The banking sector continues to demonstrate strong revenues, profits, and stable net interest income, suggesting resilience.
“There are signs of strength in the banking sector that may have been somewhat unexpected, but it is reassuring to see that the financial system remains fundamentally solid at this time,” Mulberry stated. “Nevertheless, we are monitoring the situation closely, as prolonged high interest rates can lead to increased financial stress.”