As interest rates remain at their highest levels in over two decades and inflation persists, major banks are bracing for increased 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 set aside by banks to cover potential losses from defaults, including issues like bad debt and commercial real estate loans.
JPMorgan allocated $3.05 billion towards credit loss provisions in the second quarter, while Bank of America designated $1.5 billion. Citigroup’s provisions rose dramatically to $21.8 billion, more than tripling from the previous quarter, and Wells Fargo reserved $1.24 billion.
These financial preparations indicate that banks are anticipating a more challenging lending environment, with both secured and unsecured loans potentially resulting in greater losses. According to a recent analysis by the New York Fed, American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards is increasing, leading to rising delinquency rates as many consumers deplete savings accrued during the pandemic and increasingly depend on credit. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter that balances surpassed the trillion-dollar milestone, as reported by TransUnion. Additionally, the commercial real estate sector continues to face significant challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, said, “We’re still coming out of this COVID era,” linking the state of consumer health and banking to the federal stimulus measures distributed to consumers.
Experts caution that any downturn for banks may emerge in the upcoming months. Mark Narron, a senior director at Fitch Ratings, explained, “The provisions that you see at any given quarter don’t necessarily reflect credit quality for the last three months; they reflect what banks expect to happen in the future.”
He also pointed out the shift in banking from a model where rising loan defaults triggered an increase in provisions to one where macroeconomic forecasts heavily inform provisioning strategies.
Looking ahead, banks anticipate slower economic growth, a rising unemployment rate, and predicted interest rate cuts later this year. Such conditions may lead to increased incidences of delinquency and default before the year concludes.
Citi’s CFO, Mark Mason, observed that financial struggles appear to be particularly prevalent among lower-income consumers who have seen their nest eggs diminish since the pandemic. He noted that while the overall U.S. consumer shows resilience, discrepancies exist in performance and behavior based on income and credit scores.
“As we analyze our consumer clients, only the highest income quartile shows more savings than in early 2019, and it is high FICO score customers driving spending growth and maintaining prompt payment rates,” Mason explained. Conversely, those in lower FICO brackets are experiencing declining payment rates and increased borrowing, heavily impacted by soaring inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year peak of 5.25-5.5%, waiting for inflation measures to align with its 2% target before proceeding with anticipated rate cuts.
Despite banks preparing for an uptick in defaults later this year, Mulberry asserts that current default rates do not indicate an impending consumer crisis. He notes the difference in experiences between homeowners and renters since the pandemic, explaining that while interest rates have increased, homeowners locked in low fixed-rate mortgages that shield them from immediate financial discomfort.
In contrast, renters confront concerning financial pressures due to rents rising over 30% nationwide and grocery costs increasing by 25% since 2019, without the benefit of securing low rates during that period.
For now, experts emphasize that the recent earnings reports show no alarming changes in asset quality. Robust revenues, profits, and healthy net interest income are signs of a stable banking sector. Mulberry remarked, “There’s some strength in the banking sector that I don’t know was totally unexpected… the structures of the financial system are still very strong and sound.” However, he cautioned that sustained high interest rates could lead to increased financial stress over time.