As interest rates reach levels not seen in over two decades and inflation continues to pressure consumers, major banking institutions are bracing for increased risks related to 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 represent the funds set aside by banks to cover potential losses from credit risks, including delinquent loans and bad debt.
JPMorgan allocated $3.05 billion for credit loss provisions in Q2; Bank of America set aside $1.5 billion; Citigroup’s allowance reached $21.8 billion, reflecting more than a tripling of its reserve from the previous quarter; and Wells Fargo recorded provisions of $1.24 billion.
These reserve increases indicate that banks are preparing for a riskier financial landscape, where both secured and unsecured loans may lead to greater losses for some of the largest institutions in the country. Recent data from the New York Fed shows that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards is increasing, along with delinquency rates, as individuals begin to deplete their pandemic savings and rely more on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter for such totals to exceed a trillion dollars, according to TransUnion. The commercial real estate sector remains vulnerable as well.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the ongoing recovery from the COVID-19 pandemic has strongly relied on government stimulus support for consumers.
However, the real challenges for banks may arise in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that quarterly provisions do not necessarily reflect credit quality in the past three months; instead, they signal banks’ expectations for future economic conditions.
The outlook involves anticipated slowing economic growth, increased unemployment, and projected interest rate cuts later this year, which could lead to rising delinquency and default rates as the year ends.
Citi’s chief financial officer, Mark Mason, highlighted that these concerns are especially prominent among lower-income consumers, whose savings have diminished since the pandemic began. He noted that while the U.S. consumer as a whole remains resilient, significant differences exist in spending and payment behaviors across various income levels.
“Only the highest income quartile has more savings than at the start of 2019. Customers with FICO scores above 740 are driving spending growth, while lower FICO score customers are experiencing declines in payment rates and are borrowing more due to the pressures of inflation and rising interest rates,” Mason stated.
The Federal Reserve has maintained interest rates at a 23-year high of between 5.25% and 5.5%, awaiting stabilization in inflation rates toward the central bank’s 2% target before proceeding with anticipated rate cuts.
Despite banks preparing for an uptick in defaults later this year, current default rates do not yet indicate a consumer crisis, as noted by Mulberry. He emphasized the need to look at the contrast between homeowners and renters during the pandemic.
While interest rates have significantly increased, homeowners typically locked in favorable fixed rates. Consequently, they may not feel the pressure as acutely compared to renters, who face steep rent increases – over 30% nationwide since 2019 – and rising grocery prices – up 25% during the same timeframe, leading to financial strain in their monthly budgets.
Overall, the recent earnings reports indicate consistent asset quality, according to Narron. Strong revenues, profits, and resilient net interest income suggest the banking sector remains robust.
Mulberry remarked, “The financial system’s structure is still strong and sound, but we are closely monitoring the situation, as prolonged high interest rates will inevitably create more stress.”