As interest rates remain at their highest level in over two decades and inflation weighs heavily on 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 reported an increase in their provisions for credit losses compared to the previous quarter. These provisions, set aside to cover potential losses from credit risks such as bad debts and delinquent payments, are a key indicator of banks’ expectations regarding the financial outlook.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses surged to $21.8 billion at the end of the quarter, more than tripling its reserve build from the previous quarter. Wells Fargo reported provisions totaling $1.24 billion.
The increased reserves suggest that banks are preparing for a more volatile environment, where both secured and unsecured loans pose greater risks. A recent analysis from the New York Federal Reserve revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
There has also been a rise in both credit card issuance and delinquency rates, as consumers deplete savings accrued during the pandemic and increasingly rely on credit. According to TransUnion, 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 threshold. The commercial real estate sector continues to face significant challenges as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that while the economy is still emerging from the impacts of COVID-19, stimulus measures have played a crucial role in consumer financial health.
However, the real impact on banks may be seen in the coming months. Mark Narron, a senior director at Fitch Ratings, mentioned that a bank’s provisions reflect expected future credit quality, rather than past performance.
Currently, banks are predicting slower economic growth, rising unemployment, and potential interest rate cuts later this year in September and December, which could lead to more delinquencies and defaults as 2023 draws to a close.
Citi CFO Mark Mason pointed out that financial stress appears to be concentrated among lower-income consumers, who have experienced a decline in savings since the pandemic began. He highlighted that only the highest income quartile has seen an increase in savings since early 2019, with consumers possessing FICO scores above 740 driving spending growth and maintaining high payment rates. In contrast, lower FICO band customers are facing sharper declines in payment rates and are borrowing more due to the strain of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stability in inflation measures before proceeding with anticipated rate cuts.
Despite preparations for increased defaults in the latter half of the year, experts like Mulberry suggest that the current rise in defaults does not yet indicate a looming consumer crisis. He is particularly interested in the differences between homeowners and renters from the pandemic era.
Although interest rates have risen significantly, homeowners have locked in low fixed rates, allowing them to avoid financial strain, unlike renters who faced surging rental costs.
With rents climbing over 30% nationwide and grocery prices increasing by 25% from 2019 to 2023, renters—who missed the opportunity to secure fixed low rates—are experiencing heightened financial stress.
Overall, the latest earnings reports indicate that there were no significant changes in asset quality compared to previous quarters. Strong revenues, profits, and stable net interest income are positive signs for the banking sector’s health.
Mulberry expressed cautious optimism regarding the banking sector, noting its strength and stability. However, he warned that sustained high interest rates could lead to increased financial pressure over time.