Big banks are bracing for increased risks in their lending practices as interest rates reach more than two-decade highs and inflation continues to impact consumers. In the second quarter, major banks including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside to cover potential losses from credit risks such as bad debt and delinquent loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s allowance reached $21.8 billion, tripling its reserves from the previous quarter; and Wells Fargo had provisions of $1.24 billion.
This accumulation of reserves indicates that banks are preparing for a more challenging environment, where both secured and unsecured loans could incur greater losses. A recent New York Fed analysis reported that Americans have accumulated a staggering $17.7 trillion in household debt from consumer loans, student loans, and mortgages.
Credit card usage and delinquency rates are also rising as consumers deplete their pandemic-era savings and increasingly depend on credit. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter to exceed a trillion dollars in total. Additionally, commercial real estate continues to be in a vulnerable position.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted, “We’re still coming out of this COVID era, particularly regarding banking and consumer health, primarily due to the stimulus distributed to consumers.”
However, any significant challenges for banks are expected in the coming months. Mark Narron, a senior director at Fitch Ratings, explained, “The provisions you see each quarter do not necessarily reflect recent credit quality but instead what banks anticipate for the future.”
Currently, banks are forecasting slower economic growth, increased unemployment, and potential interest rate cuts later this year. This could lead to more delinquencies and defaults as the year progresses.
Citi’s CFO Mark Mason observed that the signs of trouble seem concentrated among lower-income consumers, who have seen their savings diminish since the pandemic. He indicated a divergence in behavior among different income groups.
“Among our consumer clients, only the highest income quartile has increased savings since early 2019, with high FICO score customers leading in spending growth and maintaining solid payment rates,” Mason said. In contrast, lower FICO band customers are experiencing significant drops in payment rates and are borrowing more amid high inflation and 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 its 2% target before implementing anticipated rate cuts.
Despite the banks preparing for a potential rise in defaults in the latter half of the year, indications of a consumer crisis are not yet evident. Mulberry noted a distinction between homeowners and renters during the pandemic. “While rates have significantly increased, homeowners locked in low fixed rates and are not feeling substantial pain. Renters, however, who missed that opportunity are facing inflation pressures.”
Rent prices have surged over 30% nationwide between 2019 and 2023, coupled with a 25% increase in grocery costs during the same period, putting considerable strain on renters who didn’t secure lower rates.
As for the latest earnings reports, Narron remarked that there were no major surprises regarding asset quality. Positive indicators remain in the form of strong revenues, profits, and resilient net interest income for the banking sector.
“There’s a strength in the banking sector that, while expected, is a relief, confirming that the financial system remains robust at this time,” Mulberry concluded. However, he cautioned that prolonged high-interest rates could lead to increased stress within the system.