As interest rates reach their highest levels in over two decades and inflation continues to impact consumers, 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 represent the funds set aside by financial institutions to cover potential losses from credit risks, including delinquent or bad debts and loans, such as commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup recorded an allowance for credit losses of $21.8 billion at the quarter’s end, more than tripling its credit reserve from the previous quarter. Wells Fargo allocated $1.24 billion for the same purpose.
This increase in provisions indicates that banks are preparing for a riskier environment where both secured and unsecured loans might lead to greater losses for some of the country’s largest financial institutions. According to a recent analysis by the New York Federal Reserve, Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise as many individuals exhaust their pandemic-era savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances exceeded the trillion-dollar mark, as reported by TransUnion. Additionally, CRE remains in a vulnerable position.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented, “We’re still coming out of this COVID era, and when it comes to banking and consumer health, it was largely the stimulus deployed to the consumer that is now being assessed.”
However, banks are expected to face challenges in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted, “The provisions that you see at any given quarter don’t necessarily reflect credit quality for the last three months, but rather what banks anticipate will happen in the future.”
He explained that there has been a shift from a system where increasing loan defaults lead to higher provisions to one where macroeconomic forecasts heavily influence provisioning decisions.
In the near future, banks are forecasting slower economic growth, rising unemployment, and potential interest rate cuts in September and December. These factors could lead to more delinquencies and defaults as the year concludes.
Citigroup’s chief financial officer, Mark Mason, indicated that the warning signs appear to be particularly significant among lower-income consumers, who have seen their savings diminish significantly since the pandemic.
He stated, “While we continue to see resilience in the overall U.S. consumer, there is a noticeable divergence in performance and behavior across different FICO and income levels.”
Mason highlighted that only the highest income quartile has managed to increase their savings compared to early 2019, while higher FICO score customers contribute to spending growth and maintain high payment rates. Conversely, those with lower FICO scores are experiencing sharper declines in payment rates and are borrowing more due to the impacts of inflation and high-interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation measures towards the central bank’s 2% target before implementing the anticipated rate cuts.
Despite banks preparing for an increase in defaults later this year, there has not yet been a significant rise in defaults indicative of a consumer crisis, according to Mulberry. He pointed out the differences between homeowners who benefited from low fixed rates during the pandemic and renters who did not have the same opportunity.
He explained, “Yes, rates have increased significantly, but homeowners locked in very low fixed rates on their debts, so they aren’t feeling the pressure as much. Renters, however, are dealing with rising rents that have outpaced wage growth, leading to greater financial strain.”
Currently, analysts emphasize that there are no alarming signs regarding asset quality in the latest earnings reports. There are positive indicators of a robust banking sector, including strong revenues, profits, and resilient net interest income.
Mulberry concluded, “The banking sector is demonstrating strength that may not have been entirely expected, offering reassurance that the financial system remains sound. However, we are closely monitoring the situation, as prolonged high-interest rates could generate further stress.”