With interest rates at their highest levels in over two decades and inflation affecting consumers, major banks are bracing themselves for potential 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 financial institutions allocate to cover possible losses arising from credit risks, including bad debt and lending activities such as commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter; Bank of America allocated $1.5 billion; Citigroup’s allowance for credit losses reached $21.8 billion, significantly more than the previous quarter; and Wells Fargo’s provisions totaled $1.24 billion.
These provisions indicate that banks are preparing for a riskier lending environment, where both secured and unsecured loans might lead to greater losses. A recent analysis by the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise, driven by the depletion of pandemic-era savings and increased reliance on credit. Credit card balances reached $1.02 trillion in the first quarter this year, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar mark, according to TransUnion. The commercial real estate sector continues to face challenges as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the current economic climate, stating that the banking sector and consumer health are still recovering from the effects of COVID-19, largely influenced by government stimulus measures.
However, any challenges for banks may arise in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that quarterly provisions do not necessarily reflect the immediate credit quality but indicate banks’ expectations for future developments.
Narron noted that banks are predicting slower economic growth, a rising unemployment rate, and potential interest rate cuts later this year. This outlook may lead to an increase in delinquencies and defaults as the year progresses.
Citi’s chief financial officer, Mark Mason, highlighted that warning signs are particularly evident among lower-income consumers, who have seen their savings decline since the pandemic.
Mason mentioned that while the overall U.S. consumer remains resilient, performance varies significantly across different income and credit score categories. Only the top income quartile has managed to save more than at the start of 2019, with higher FICO score customers leading in spending growth and maintaining payment rates. In contrast, lower FICO score customers are experiencing declines in payment rates and increasing borrowing, influenced by rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it monitors inflation trends, aiming towards a target rate of 2% before proceeding with expected rate cuts.
Despite banks preparing for potential defaults in the latter half of the year, Mulberry believes that current default rates do not indicate an impending consumer crisis. He pointed out that homeowners who secured fixed-rate mortgages during the pandemic are not feeling as much financial strain as renters, who are facing significant increases in rental costs.
According to Mulberry, rents have surged by more than 30% across the country from 2019 to 2023, with grocery prices rising by 25%, causing financial stress primarily for renters who have not benefited from fixed loan rates.
For now, the latest quarterly earnings reports show no significant new issues regarding asset quality. Strong revenues, profits, and resilient net interest income suggest that the banking sector remains healthy.
Narron concluded that although there are positive signs, the banking sector is under surveillance, as prolonged high interest rates may lead to increased financial stress.