Amidst interest rates reaching over two-decade highs and ongoing inflation pressures on consumers, major banks are bracing for increased risks in 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 banks to cover potential losses from credit risks, which include delinquent accounts and bad debt arising from loans, particularly in commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s allowance for credit losses surged to $21.8 billion by the end of the quarter, more than tripling its previous reserves; and Wells Fargo’s provisions amounted to $1.24 billion.
These reserves indicate that banks are preparing for a riskier financial environment, where both secured and unsecured loans might yield greater losses for some of the largest financial institutions. An analysis from the New York Federal Reserve revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as individuals deplete the savings accrued during the pandemic and increasingly rely on credit. According to TransUnion, total credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that cardholder debts surpassed the trillion-dollar threshold. The CRE sector is also showing signs of instability.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked that the finance sector is still navigating the fallout from the COVID-19 era, primarily due to the stimulus support provided to consumers.
However, the impact on banks is expected to become more pronounced in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that the provisions noted in any given quarter do not necessarily reflect recent credit quality but rather banks’ expectations for future economic conditions.
He added that the financial landscape has shifted from a traditional model, where rising loan defaults prompted increased provisions, to a system where macroeconomic forecasts play a significant role in determining provisioning.
In the near term, banks anticipate slower economic growth, a potential rise in unemployment, and two expected interest rate cuts later this year, which could lead to increased delinquencies and defaults by year-end.
Citigroup’s chief financial officer, Mark Mason, highlighted that observed warning signs appear most prevalent among lower-income consumers, who have seen their savings diminish since the pandemic began.
“While the U.S. consumer remains generally resilient, we see a divergence in performance based on income and credit scores,” Mason stated in a recent analyst call. “Higher-income clients have more savings than in early 2019, and those with credit scores above 740 are driving spending growth and maintaining good payment rates. In contrast, customers with lower credit scores are facing more challenges.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it awaits a stabilization of inflation towards the 2% target before implementing anticipated rate cuts.
Despite banks anticipating wider defaults in the latter half of the year, current defaults are not rising at levels indicative of a consumer crisis, according to Mulberry. He is particularly observing the contrast between homeowners and renters from the pandemic era.
“High interest rates have significantly impacted the market, but homeowners locked in low fixed rates and aren’t experiencing the same financial strain,” Mulberry noted. “Renters, however, missed that opportunity.”
With rent prices rising more than 30% and grocery costs increasing by 25% from 2019 to 2023, renters who did not secure favorable rates and are facing rental costs that surpass wage growth are experiencing the most financial hardship, according to Mulberry.
As for the recent earnings reports, Narron noted that there was nothing significant in terms of asset quality changes. Strong revenues, profits, and a resilient net interest income signal a still-healthy banking sector.
“There is strength within the banking system that may not have been entirely unexpected, but it’s reassuring to see that the foundations of financial institutions remain robust,” Mulberry said. “However, continued high interest rates are expected to create additional stress.”