With interest rates reaching their highest levels in over two decades and persistent inflation affecting consumers, major banks are gearing up to navigate additional 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 reserves that banks allocate to cover potential losses from credit risks, such as bad debt and delinquent loans, including those tied to commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the quarter’s end, marking an increase of more than three times its previous credit reserve. Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves indicate that banks are bracing for a more challenging lending environment where both secured and unsecured loans may lead to greater losses. A recent analysis by the New York Fed revealed that Americans are collectively burdened by $17.7 trillion in consumer loans, student debt, and mortgages.
Credit card issuance and delinquency rates are also on the rise as pandemic-related savings dwindle, pushing consumers to rely more heavily on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter that these balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector remains particularly vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the repercussions of the COVID-19 era continue to impact the banking sector and consumer health, primarily influenced by prior stimulus measures.
However, any significant issues for banks are anticipated in the forthcoming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, pointed out that the provisions reported in any given quarter reflect banks’ future expectations regarding credit quality rather than historical performance.
“The shift has moved towards a system where macroeconomic forecasts drive provisioning,” Narron explained. Currently, banks predict slowing economic growth, increased unemployment, and potential interest rate cuts later this year, which may lead to higher delinquency and default rates as the year concludes.
Citi’s chief financial officer, Mark Mason, highlighted that warning signs are predominantly seen among lower-income consumers, who have experienced a decline in savings since the pandemic began. He emphasized that while the overall U.S. consumer resilience remains, there’s a noticeable disparity across various income levels.
“Only the highest income quartile has more savings compared to early 2019, and those with FICO scores above 740 are the primary drivers of spending growth and steady payment rates,” Mason noted. In contrast, consumers in lower FICO categories are facing declining payment rates and are borrowing more, adversely affected by high inflation and interest rates.
The Federal Reserve has maintained interest rates between 5.25% to 5.5%, holding steady at a 23-year high as it monitors inflation toward its target of 2% before implementing expected rate cuts.
Despite banks’ preparations for increased defaults later in the year, Mulberry noted that the current default rates do not indicate an imminent consumer crisis. He is closely observing the divide between homeowners and renters from the pandemic era, noting that homeowners secured low fixed-rate mortgages and were less impacted by rising rates, unlike renters who did not have that opportunity.
As rents have surged over 30% nationally from 2019 to 2023, and grocery costs have risen by 25%, renters who faced escalating rents without corresponding wage growth are experiencing significant financial strain.
Overall, the latest earnings reports indicate that “nothing new” emerged in terms of asset quality, Narron observed. Strong revenues, profits, and resilient net interest income are generally positive signs for the banking sector.
Mulberry concluded that while the banking system remains robust, prolonged high interest rates will continue to exert pressure on consumers and financial institutions alike.