With interest rates reaching more than 20-year highs and inflation continuing to pressure consumers, major banks are bracing for increased challenges related to their lending practices.
In the second quarter, prominent banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all raised their provisions for credit losses compared to the previous quarter. These provisions refer to funds that financial institutions set aside to cover potential losses arising from credit risks, which includes delinquent debts and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup reported a total allowance for credit losses of $21.8 billion by the end of the quarter, significantly increasing its reserve build from the previous quarter. Wells Fargo allocated $1.24 billion for provisions.
These increased provisions signal that banks are preparing for a more challenging financial environment, where both secured and unsecured loans could result in greater losses. According to a recent analysis by the New York Federal Reserve, American households collectively owe approximately $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as consumers deplete their savings accrued during the pandemic and increasingly rely on credit. As of the first quarter of this year, total credit card balances reached $1.02 trillion, marking the second consecutive quarter in which the combined balances exceeded this threshold. The commercial real estate sector remains particularly vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, indicated that the banking environment is still feeling the effects of the COVID-19 pandemic, largely due to the stimulus measures implemented during that period.
However, any potential issues for banks are expected to manifest in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reflected in a given quarter do not necessarily represent recent credit quality but rather the banks’ expectations for the future.
He noted a shift in the banking system from traditionally reacting to bad loans to now relying on macroeconomic forecasts that influence provisioning practices.
Looking ahead, banks anticipate slowing economic growth, a rise in unemployment, and two interest rate cuts later this year. This outlook suggests an increase in delinquencies and defaults could occur as the year ends.
Citi’s chief financial officer, Mark Mason, highlighted that the warning signs appear concentrated among lower-income consumers, who have seen their savings diminish since the pandemic began. Mason pointed out that while the overall U.S. consumer remains resilient, there’s noticeable divergence in performance across different income brackets.
He noted that only the highest income quartile has maintained more savings than at the start of 2019, and it is customers with higher credit scores driving growth in spending and maintaining high payment rates. In contrast, those with lower credit scores are experiencing significant drops in payment rates and are increasingly reliant on borrowing due to the impacts of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation measures toward the central bank’s target of 2% before potentially implementing rate cuts.
Despite banks preparing for higher defaults in the latter half of the year, indications suggest that defaults have not yet risen at levels indicative of a consumer crisis. Mulberry is particularly focused on the divide between homeowners and renters during the pandemic.
He pointed out that although interest rates have increased significantly, homeowners locked in low fixed rates on their mortgages, allowing them to avoid significant financial strain. Meanwhile, renters—who couldn’t secure favorable rates during the pandemic—are now facing substantial stress, with rents rising over 30% and grocery costs increasing by 25% between 2019 and 2023.
However, the latest earnings reports indicate that asset quality remains stable. Narron emphasized that strong revenues, profits, and robust net interest income are positive signs for the banking sector’s health.
Mulberry concluded by noting that the resilience of the banking sector is reassuring, and while it is not entirely unexpected, it underscores the strength and stability of the financial system at this moment. He acknowledged that the prolonged duration of high interest rates could lead to increased stress in the future.