With interest rates at their highest in over two decades and inflation impacting consumers significantly, major banks are preparing for increased risks in 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 set aside by banks to cushion against potential losses from credit risks, such as delinquent loans and bad debt, including commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance reached $21.8 billion at the end of the quarter, more than tripling its reserves from the prior period. Wells Fargo’s provisions totaled $1.24 billion.
These rising reserves indicate that banks are bracing for a more challenging environment, where both secured and unsecured loans may lead to greater losses. A recent report by the New York Fed highlighted that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card use and delinquency rates have also climbed as consumers deplete their pandemic-era savings and turn more frequently to credit. Total credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that balances exceeded a trillion dollars, according to TransUnion. Additionally, commercial real estate continues to face uncertainty.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked on the lingering effects of the COVID-19 era, attributing current banking conditions to the stimulus efforts deployed to aid consumers.
Experts suggest that any challenges for banks may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, explained that the provisions reflected in each quarter do not solely indicate credit quality from the past three months but rather the banks’ expectations for the future.
As banks anticipate a slowdown in economic growth, higher unemployment rates, and potential interest rate cuts in September and December, they expect more delinquencies and defaults as the year progresses.
Citi’s CFO, Mark Mason, pointed out that concerning trends are particularly pronounced among lower-income consumers, who have seen their savings diminish post-pandemic.
Despite an overall resilient U.S. consumer base, Mason noted a divergence in spending and payment behavior across different income brackets. The highest income quartile has maintained more savings compared to early 2019, while those in lower FICO bands are experiencing declines in payment rates, driven by the pressures of high inflation and interest rates.
The Federal Reserve has kept interest rates steady at 5.25-5.5% in a bid to stabilize inflation towards its 2% target ahead of anticipated rate cuts.
Although banks are bracing for potential defaults later in the year, Mulberry indicated that defaults have not yet increased to the level indicating a consumer crisis. He is particularly monitoring the situation among homeowners versus renters, noting that many homeowners secured low fixed rates during the pandemic, while renters did not have the same opportunity.
With rental prices soaring over 30% between 2019 and 2023, combined with a 25% hike in grocery prices during the same timeframe, renters are experiencing significant financial strain as their wages struggle to keep pace with rising costs.
For now, the most significant conclusion from the latest earnings reports is that there are no alarming trends regarding asset quality, according to Narron. Strong revenues, profits, and robust net interest income point to a banking sector that remains generally healthy.
Mulberry commented on the strength of the financial system, stating that while this resilience is reassuring, continuous high interest rates will produce increasing stress.