As interest rates remain at their highest levels in over two decades, and inflation continues to impact consumers, major banks are bracing for increased risks related to their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks set aside to cover potential losses from credit risks, including bad loans and issues related to commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit losses; Bank of America set aside $1.5 billion; Citigroup’s allowance rose dramatically to $21.8 billion, more than tripling its reserves from the prior quarter; and Wells Fargo provisioned $1.24 billion.
These adjustments indicate that banks are preparing for a riskier financial landscape where both secured and unsecured loans may lead to greater losses. A recent analysis by the New York Fed revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates have risen as consumers exhaust their pandemic-era savings and increasingly rely on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter that total balances surpassed the trillion-dollar milestone, according to TransUnion. Furthermore, the CRE sector continues to face challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the ongoing effects of the COVID era and the impact of stimulus measures on consumer banking health.
Looking forward, banks are anticipating potential challenges ahead. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, pointed out that current provisions reflect banks’ expectations for future credit quality rather than the past three months’ performance.
Banks are projecting a slowdown in economic growth, an increase in unemployment, and anticipate two interest rate cuts later this year, which could lead to more delinquencies and loan defaults.
Citigroup’s Chief Financial Officer, Mark Mason, highlighted that economic red flags predominantly affect lower-income consumers, whose savings have diminished since the pandemic.
“While the overall U.S. consumer remains resilient, we observe varying performance levels across different income brackets,” Mason stated. He noted that only the highest-income quartile has more savings now compared to early 2019, and customers with high credit scores are driving spending growth and maintaining their payment rates. In contrast, those in lower credit score bands are experiencing declines in payment rates and are borrowing more due to the pressures of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25% to 5.5% while waiting for inflation to stabilize towards its 2% target before implementing any expected rate cuts.
Despite banks anticipating increased defaults in the latter half of the year, current rates of default do not signal an imminent consumer crisis, according to Mulberry. He emphasized the difference in experiences between homeowners and renters since the pandemic; while interest rates have surged, homeowners who locked in low fixed rates are less affected than renters, who are facing substantial rent increases and rising living costs.
Mulberry noted that rents have soared over 30% nationwide between 2019 and 2023, while grocery prices have risen by 25%. Renters are experiencing significant strain on their budgets compared to those who have secured lower rates on home loans.
Overall, the latest earnings reports indicate no major changes in asset quality across banks. Despite the challenges, robust revenues, profits, and strong net interest income suggest a healthier banking sector than anticipated. “There’s a resilience in the banking sector that provides reassurance regarding the strength of the financial system, especially as long as interest rates remain elevated,” Mulberry concluded.