As interest rates remain at their highest levels in over two decades and inflation continues to pressure 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 set aside by financial institutions to cover potential losses from credit risks, including delinquent debts and lending, particularly in commercial real estate (CRE).
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, significantly increasing its reserves from the previous quarter; and Wells Fargo recorded provisions of $1.24 billion.
These reserve increases indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans could lead to greater losses. The New York Federal Reserve recently reported that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as people exhaust their pandemic-era savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total cardholder balances surpassed the trillion-dollar mark, according to TransUnion. Additionally, the CRE sector remains unstable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the current banking landscape, stating, “We are still emerging from the COVID era, particularly regarding banking and consumer health, largely due to the stimulus that was provided to consumers.”
However, any challenges for banks may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported at any quarter do not necessarily reflect past credit quality but rather banks’ expectations for the future.
“As we transition from a historical model where provisions increased as loans started to default, we now see a system driven by macroeconomic forecasts influencing provisions,” Narron noted.
In the near future, banks anticipate slower economic growth, an increase in unemployment, and potential interest rate cuts later this year in September and December, which could lead to more delinquencies and defaults as the year concludes.
Citi’s CFO Mark Mason indicated that these concerns seem concentrated among lower-income consumers, who have seen their savings diminish since the pandemic. He highlighted a disparity in performance among different income groups, stating, “While the overall U.S. consumer appears resilient, there is a noted divergence based on income and credit scores.”
Mason elaborated that only the top income quartile has maintained higher savings since before the pandemic, while lower FICO score customers are experiencing a decline in payment rates and are borrowing more due to the impacts of high inflation and interest rates.
The Federal Reserve’s interest rates currently sit at a 23-year high of 5.25-5.5%, pending stabilization of inflation towards the central bank’s 2% target before executing expected rate cuts.
Despite banks anticipating increased defaults later in the year, Mulberry cautioned that current default rates are not indicative of a consumer crisis. He is particularly observing the differences between homeowners and renters during this period, noting that homeowners locked in low fixed-rate mortgages and are not feeling as much financial strain compared to renters facing rising rental prices.
With rents climbing over 30% nationwide from 2019 to 2023 and grocery costs increasing by 25%, renters, who did not capitalize on low mortgage rates, are under significant budgetary stress.
Overall, the latest earnings reports did not reveal any concerning trends regarding asset quality, according to Narron. Strong revenues, profits, and resilient net interest income signals a still-robust banking sector. Mulberry expressed a sense of reassurance about the financial system’s current strength but warned that sustained high interest rates could introduce stress in the future.