As interest rates reach their highest levels in over two decades and inflation continues to impact consumers, major banks are preparing 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 are funds that banks allocate to cover potential losses from credit risks, which include delinquent debts and loans, such as commercial real estate (CRE) loans.
Specifically, JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup increased its allowance for credit losses to $21.8 billion, more than tripling its reserves from the previous quarter, and Wells Fargo had provisions of $1.24 billion.
These increased reserves indicate that banks are bracing for a more challenging economic environment, where both secured and unsecured loans could lead to greater losses. A recent analysis by the New York Federal Reserve revealed that Americans carry a staggering total of $17.7 trillion in debt across consumer loans, student loans, and mortgages.
Additionally, credit card issuances and delinquency rates are climbing as consumers exhaust their pandemic-era savings and turn increasingly to credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that balances exceeded the trillion-dollar threshold, according to TransUnion. The commercial real estate sector remains in a vulnerable state as well.
“We’re still emerging from the COVID period, especially concerning banking and consumer health, which was significantly influenced by the stimulus provided to consumers,” stated Brian Mulberry, a portfolio manager at Zacks Investment Management.
However, potential challenges for banks are anticipated in the upcoming months. “The provisions seen in any quarter don’t necessarily reflect the credit quality over the past three months; they are more indicative of what banks expect in the future,” explained Mark Narron, a senior director at Fitch Ratings.
He noted a shift from a traditional approach where rising loan defaults led to increased provisions, to a model driven more by macroeconomic forecasts.
In the near term, banks expect slower economic growth, a rise in unemployment rates, and potential interest rate cuts in September and December, which may contribute to further delinquencies and defaults as the year concludes.
Citi’s CFO Mark Mason pointed out that emerging warning signs are predominantly among lower-income consumers, who have seen their savings significantly diminish since the pandemic.
“While the overall U.S. consumer remains resilient, there is a clear divergence in performance and behavior across different income levels and credit scores,” Mason shared during a recent analyst call.
He highlighted that only consumers in the top income quartile have managed to retain more savings than they had at the start of 2019, with those possessing high FICO scores driving spending and maintaining high repayment rates. Conversely, customers with lower credit scores are experiencing sharper declines in payment rates while increasing their borrowing, adversely affected by soaring inflation and interest rates.
The Federal Reserve has sustained interest rates at a 23-year high of 5.25-5.5% as it awaits inflation indicators to stabilize toward its 2% target prior to implementing anticipated rate cuts.
Despite banks gearing up for a rise in defaults in the latter half of the year, current data does not indicate a consumer crisis, according to Mulberry. He is particularly monitoring the disparity between those who owned homes during the pandemic and those who rented.
“While interest rates have emerged significantly since then, homeowners benefited from locking in very low fixed rates, so they aren’t currently feeling the pinch, unlike renters who lacked that opportunity,” Mulberry remarked.
With national rents surging over 30% and grocery prices climbing by 25% from 2019 to 2023, renters facing rental prices that have outstripped wage growth are under the most financial strain.
For now, the primary insight from the latest earnings reports is that “there hasn’t been anything new this quarter regarding asset quality,” according to Narron. Encouragingly, strong revenues, profits, and robust net interest income continue to suggest a healthy banking sector.
“There is some strength within the banking sector, which is reassuring, affirming that the financial system’s structures remain robust,” Mulberry concluded. “However, we will continue to monitor the situation closely, as prolonged high interest rates will exert increasing stress.”