With interest rates at their highest levels in over 20 years and inflation continuing to impact consumers, major banks are preparing for increased risks stemming from their lending practices.
During 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 funds set aside by financial institutions to cover potential losses from credit risks, including delinquent or bad debts, as well as commercial real estate (CRE) loans.
JPMorgan designated $3.05 billion for credit loss provisions in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, reflecting a more than threefold increase from the prior quarter. Wells Fargo set aside $1.24 billion for this purpose.
These precautionary measures demonstrate that banks are bracing for a tougher lending environment, where both secured and unsecured loans might lead to greater losses for some of the nation’s largest banks. A recent analysis from the New York Fed revealed that Americans have accumulated a total of $17.7 trillion in household debt, encompassing consumer loans, student loans, and mortgages.
Moreover, credit card issuance and delinquency rates are trending upward as individuals deplete their pandemic-era savings and increasingly turn to credit. In the first quarter of this year, total credit card balances soared to $1.02 trillion, marking the second consecutive quarter where cumulative cardholder balances exceeded one trillion, according to TransUnion. The situation for commercial real estate also remains uncertain.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted, “We’re still coming out of this COVID era, particularly regarding banking and consumer health, which was heavily influenced by the stimulus measures implemented for consumers.”
Looking ahead, banks anticipate potential challenges.
Mark Narron, a senior director at Fitch Ratings, explained, “The provisions reported in any given quarter do not necessarily indicate credit quality for those three months; they reflect banks’ expectations of future developments.” He added that the industry has shifted from a reliance on historical data regarding bad loans to a reliance on macroeconomic forecasts to shape provisioning.
In the short term, banks are expecting slow economic growth, increased unemployment rates, and two interest rate cuts later this year. This situation could result in more delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, observed that these concerning trends seem to be predominantly affecting lower-income consumers, who have seen their savings diminish since the pandemic began.
“While we see an overall resilient U.S. consumer, there is a noticeable divergence in performance and behavior across different income and credit score bands,” Mason stated during a recent analysts’ call. He pointed out that only the highest income quartile has maintained more savings than they did at the start of 2019, with those in the over-740 FICO score range driving spending growth and keeping up with payments. Conversely, customers in lower FICO bands are experiencing significant drops in payment rates and are borrowing more, feeling the pressure from high inflation and interest rates.
The Federal Reserve has kept interest rates at a 23-year high of 5.25% to 5.5%, awaiting stabilization in inflation to align with its 2% target before proceeding with anticipated rate cuts.
Despite banks’ preparations for an uptick in defaults later this year, Mulberry emphasized that defaults have not surged to a level indicating a consumer crisis. He noted the contrast between those who owned homes during the pandemic and renters, stating, “While rates have increased significantly, homeowners secured very low fixed rates on their debts, and thus are not feeling the same impact.”
In contrast, renters—who did not have the chance to lock in low rates—are facing increasing rent prices, which have risen over 30% nationwide from 2019 to 2023, and grocery costs, which have surged by 25% during the same period. This situation is causing significant strain on their monthly budgets.
Currently, the primary takeaway from the recent earnings reports is that there were no significant changes in asset quality this quarter. Indicators such as strong revenues, profits, and resilient net interest income paint a generally positive picture of the banking sector’s health.
Mulberry commented, “There is strength in the banking system that is reassuring. The underlying structure of the financial system remains robust and sound at this time. However, we are monitoring the situation closely, as prolonged high interest rates will likely increase pressure on the system.”