With interest rates reaching levels not seen in over two decades and inflation continuing to impact consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, leading banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions represent funds set aside by financial institutions to cover potential losses from credit risks, including bad debts and lending, particularly in commercial real estate.
JPMorgan allocated $3.05 billion for credit loss provisions in 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 reserve build from the previous quarter. Wells Fargo established provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier environment, where both secured and unsecured loans may lead to larger losses for some of the country’s largest financial institutions. A recent analysis by the New York Federal Reserve revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are on the rise as individuals deplete 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 in which total card balances surpassed a trillion dollars, according to TransUnion. Commercial real estate also remains in a delicate state.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking sector is still navigating the aftermath of the COVID-19 pandemic, heavily influenced by government stimulus provided to consumers.
However, banks anticipate challenges ahead. Mark Narron, a senior director with Fitch Ratings, noted that current credit provisions reflect not just recent performance but also banks’ expectations for the future.
He explained that the industry has shifted from a system where loan performance primarily influenced provisions to one where macroeconomic forecasts significantly drive these decisions. In the near future, banks are predicting slower economic growth, rising unemployment, and potential interest rate cuts later this year, which could contribute to increasing delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, indicated that warning signs are particularly evident among lower-income consumers, who have experienced a decline in their savings since the pandemic.
While the overall U.S. consumer remains resilient, Mason observed a discrepancy in performance across different income levels and credit scores. He noted that only the highest income quartile retains more savings compared to early 2019, with a portion of the spending growth coming from customers with FICO scores over 740. In contrast, those with lower credit scores are struggling more with payment rates and are increasingly relying on credit due to high inflation and interest rates.
The Federal Reserve continues to maintain interest rates at a 23-year high of 5.25% to 5.5%, awaiting stabilization in inflation rates toward its target of 2% before implementing anticipated rate cuts.
Despite banks’ preparations for greater defaults later in the year, current default rates do not indicate a consumer crisis, as noted by Mulberry. He emphasized the disparity between homeowners and renters during the pandemic. Homeowners, by securing low fixed rates, are less impacted by rising rates, while renters face escalating rents and grocery prices that have surged by more than 30% and 25%, respectively, from 2019 to 2023.
For the time being, the most significant observation from the latest earnings reports is that there were no alarming trends in asset quality. Strong revenues, profits, and ongoing net interest income point to a relatively healthy banking sector.
Mulberry expressed relief that the financial system remains robust despite the prolonged period of high interest rates, but acknowledged that continuous high rates could lead to increasing stress in the future.