With interest rates reaching levels not seen in over 20 years and inflation continuing to pressure consumers, major banks are gearing up to handle 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 represent the funds that banks set aside to cover potential losses arising from credit risks, including delinquent debts and various types of loans, such as commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit losses during the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, more than tripling its provisions from the prior quarter. Wells Fargo reported provisions of $1.24 billion.
The increase in provisions indicates that banks are preparing for a more challenging economic climate, where both secured and unsecured loans may lead to greater losses. A recent analysis by the New York Fed revealed that Americans owe a total of $17.7 trillion in various forms of consumer loans, including student loans and mortgages.
Additionally, credit card issuance is rising alongside delinquency rates, as many individuals are depleting their pandemic-era savings and turning increasingly to credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total balances surpassed the trillion-dollar threshold, according to TransUnion. Furthermore, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented, “We’re still emerging from the COVID era, particularly in terms of banking and consumer health, largely influenced by the stimulus provided to consumers.”
However, challenges for banks are expected in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, pointed out that the provisions reported by banks in any given quarter do not necessarily reflect the credit quality of the past three months; rather, they represent what banks anticipate for the future.
He added, “Historically, when loans began to default, banks would increase provisions, but now the macroeconomic outlook largely determines provisioning.”
Looking ahead, banks are forecasting a slowdown in economic growth, rising unemployment rates, and two anticipated interest rate cuts later this year in September and December. This may lead to increased delinquencies and defaults as the year progresses.
Citi’s chief financial officer, Mark Mason, highlighted that these warning signs seem to be more pronounced among lower-income consumers, who have seen their savings diminish since the pandemic began. “While we continue to see a generally resilient U.S. consumer, there is a noticeable divergence in performance and behavior across different income levels,” Mason stated.
He further noted that only consumers in the highest income quartile have more savings compared to the beginning of 2019, with customers holding scores above 740 on the FICO scale driving spending growth and maintaining high payment rates. Conversely, lower FICO band customers are facing a more pronounced decline 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 5.25-5.5% while waiting for inflation measures to stabilize toward the central bank’s 2% target before implementing any anticipated rate cuts.
Despite the banks bracing for an increase in defaults later this year, current default rates are not yet indicative of a consumer crisis, according to Mulberry. “While rates have risen significantly, homeowners secured low fixed rates during that time and are still not experiencing severe discomfort. Renters, however, did not have this advantage,” he explained.
As the cost of rent has increased by over 30% nationwide from 2019 to 2023 and grocery costs surged by 25%, renters who didn’t lock in lower rates are under more financial strain, facing rental prices that have outpaced wage growth.
For the moment, the latest earnings reports suggest that there were no new developments regarding asset quality. In fact, solid revenues, profits, and resilient net interest income paint a favorable picture of the banking sector’s health.
“There’s a certain strength in the banking sector that, while not entirely unexpected, is reassuring, indicating that the financial system remains robust and sound at this time,” Mulberry concluded. Nonetheless, he cautioned that sustained high-interest rates could lead to increased stress in the sector.