As interest rates remain at their highest in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, leading banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo heightened 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 defaults and delinquent loans like those in commercial real estate.
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 reached $21.8 billion, more than triple its previous quarter’s increase, and Wells Fargo reported $1.24 billion in provisions.
This buildup indicates that banks are preparing for a potentially riskier environment, as both secured and unsecured loans may lead to greater losses for some of the country’s largest financial institutions. 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.
With credit card issuance and the associated delinquency rates on the rise, many Americans are increasingly relying on credit as their savings from the pandemic era dwindle. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter with total balances surpassing the trillion-dollar mark, according to TransUnion. Moreover, the commercial real estate sector remains in a delicate position.
“We are still emerging from the COVID era, particularly concerning banking and consumer health, largely due to the stimulus provided to consumers,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, potential issues for banks are anticipated in the forthcoming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, emphasized that the provisions reported each quarter do not necessarily represent the actual credit quality of loans over the previous three months, but rather reflect banks’ expectations for future conditions.
Furthermore, banks are forecasting slowing economic growth, an increase in unemployment rates, and anticipated interest rate cuts later this year in September and December, which may lead to more delinquencies and defaults as the year concludes.
Citigroup’s chief financial officer Mark Mason indicated that these warning signs are particularly pronounced among lower-income consumers who have seen their savings diminish since the pandemic began. “While we continue to observe an overall resilient U.S. consumer, there remains a discrepancy in performance and behavior across different income bands,” Mason remarked in a recent analyst call.
He noted that only the highest-income quartile has maintained more savings than they had in early 2019, with consumers boasting FICO scores above 740 driving spending growth and sustaining high payment rates. In contrast, those with lower credit scores are experiencing significant drops in payment rates and increasing borrowing as they face more severe impacts from high inflation and interest rates.
The Federal Reserve has held interest rates steady at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation metrics toward its 2% target before executing much-anticipated rate cuts.
Despite banks preparing for more defaults in the latter half of the year, Mulberry indicates that default rates have not yet risen to a level signaling a consumer crisis. He is particularly monitoring the division between homeowners and renters during the pandemic.
“While interest rates have risen considerably, homeowners locked in low fixed rates on their debt and are not feeling as much pain,” Mulberry explained. “Renters, however, did not benefit from this opportunity.”
With rental prices increasing by over 30% nationwide and grocery costs rising by 25% from 2019 to 2023, renters who could not secure low rates are now under significant pressure on their monthly budgets.
Despite these concerns, Narron noted that the latest earnings report did not reveal anything new regarding asset quality. Strong revenues, profits, and stable net interest income are positive signs for the ongoing health of the banking sector.
“There is some strength in the banking sector that may not have been entirely unexpected, but it is reassuring to see that the foundations of the financial system remain robust at this time,” Mulberry stated. “However, we are closely monitoring the situation, as prolonged high-interest rates will inevitably increase stress.”