With interest rates at their highest in over two decades and inflation putting pressure on consumers, major banks are bracing for increased risks in their lending activities.
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 financial institutions to cover potential losses from credit risks, including overdue debts and lending, particularly in commercial real estate.
JPMorgan set aside $3.05 billion for credit losses in the second quarter; Bank of America allocated $1.5 billion; Citigroup’s allowance totaled $21.8 billion at the end of the quarter, a significant increase from the prior quarter; and Wells Fargo reported provisions of $1.24 billion.
These increased provisions indicate that banks are preparing for a riskier environment, where both secured and unsecured lending could lead to greater losses. A recent study by the New York Fed revealed that Americans are carrying a combined $17.7 trillion in consumer loans, student loans, and mortgages.
Rising credit card issuance and delinquency rates coincide with consumers depleting their pandemic savings and leaning heavily on credit. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where balances surpassed the trillion-dollar threshold, as reported by TransUnion. The commercial real estate sector also remains unstable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the economy is still recovering from the impacts of COVID-19, largely due to the significant stimulus measures directed at consumers.
Potential issues for banks are expected in the coming months. “The provisions reported in any given quarter reflect not just past credit quality but also banks’ forward-looking expectations,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
He mentioned that the financial outlook has shifted to one where macroeconomic forecasts heavily influence provisioning strategies. Currently, banks predict an economic slowdown, rising unemployment rates, and potential interest rate cuts later in the year, which could result in higher delinquency and default rates.
Citi’s CFO Mark Mason indicated that the warning signs are especially prevalent among lower-income consumers, who have seen their savings decline since the pandemic. He noted that only the highest income quartile has managed to save more than they did in early 2019, with customers holding high FICO scores contributing positively to spending and payment rates. In contrast, lower FICO score customers are experiencing significant drops in payment rates and increasing borrowing due to the impacts of inflation and high interest rates.
The Federal Reserve has held interest rates steady at 5.25-5.5%, the highest level in 23 years, pending stabilization of inflation towards the central bank’s 2% target before potential rate cuts.
Despite banks preparing for a rise in defaults later this year, Mulberry believes current default rates do not suggest a consumer crisis. He emphasizes the distinction between homeowners and renters post-pandemic, stating that homeowners have largely benefited from low fixed-rate mortgages, while renters are facing escalating costs without similar protections.
Rents have surged over 30% nationwide from 2019 to 2023, and grocery prices have increased by 25%, creating significant budgetary pressure for renters who did not secure low rates during previous years.
Overall, the latest earnings reports revealed stability in asset quality, with strong revenue and profit margins, indicating a resilient banking sector. Mulberry concluded that while there are positive signs, the longevity of high interest rates could introduce more strain.