As interest rates remain at their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for potential risks associated with their lending practices.
In the second quarter, large financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions indicate the amount of money banks set aside to mitigate potential losses from credit risks, including defaults on loans and bad debt, particularly in the commercial real estate sector.
JPMorgan reported a provision for credit losses of $3.05 billion, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses surged to $21.8 billion by the end of the quarter, more than tripling its previous quarter’s reserves, and Wells Fargo recorded provisions amounting to $1.24 billion.
These increased provisions suggest that banks are cautioning themselves against a potentially tougher economic environment, with both secured and unsecured loans possibly leading to larger losses. A recent analysis from the New York Fed revealed that U.S. households owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise, as individuals are depleting their pandemic-era savings and leaning more on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, the second consecutive quarter surpassing the trillion-dollar mark, according to TransUnion. The commercial real estate sector also remains in a vulnerable situation.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the ongoing effects of the COVID era and noted that financial institutions deployed significant stimulus to support consumers during that time.
However, banks may face challenges in the months ahead. Mark Narron, a senior director at Fitch Ratings, explained that the provisions indicated in a given quarter may not directly correlate with recent credit quality but instead reflect banks’ expectations for future developments.
He noted a shift in the banking landscape where macroeconomic forecasts are increasingly driving provisioning practices.
In the near term, banks anticipate slowing economic growth, rising unemployment, and two expected interest rate cuts later this year, in September and December, which could lead to more delinquencies and defaults as the year ends.
Citi’s chief financial officer, Mark Mason, highlighted that the concerning trends seem to be focused on lower-income consumers, who have seen a decrease in their savings since the pandemic.
“While we continue to see an overall resilient U.S. consumer, we also see a divergence in performance among various income levels,” Mason shared during a recent analyst call. He pointed out that only the highest income quartile has maintained more savings than in 2019, with customers having FICO scores above 740 driving spending growth and maintaining high payment rates. In contrast, those with lower FICO scores are facing declining payment rates and are borrowing more amid high inflation and interest rates.
The Federal Reserve has maintained interest rates at a range of 5.25-5.5%, the highest in 23 years, as it awaits inflation indicators to stabilize at the central bank’s target of 2% before implementing anticipated rate cuts.
Despite banks preparing for increased defaults later this year, analysts note that current defaults are not yet rising to levels indicating a consumer crisis. Mulberry is particularly monitoring the differences between homeowners and renters since the pandemic began.
While interest rates have risen significantly, homeowners have generally benefited by locking in low fixed rates, which has shielded them from the significant cost increases. Conversely, renters have faced rising costs, with national rents increasing more than 30% from 2019 to 2023, coupled with grocery prices going up 25%, leading to greater financial strain for those who did not secure low rates.
Overall, the latest earnings reports revealed no new concerning trends in asset quality, highlighting strong revenues and profits, which continue to indicate a resilient banking sector. Mulberry expressed relief at the current strength of the financial system, although he noted that persistent high-interest rates could increase stress in the future.