With interest rates reaching levels not seen in over two decades and inflation continuing to impact consumers, major banks are bracing for increased risks related to 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 funds that financial institutions set aside to mitigate potential losses from credit risks, such as delinquent loans and issues in areas like commercial real estate.
Specifically, JPMorgan allocated $3.05 billion for credit losses, Bank of America set aside $1.5 billion, Citigroup’s total reached $21.8 billion—marking a more than triple increase from the prior quarter—and Wells Fargo reported provisions of $1.24 billion.
The provisions reflect banks’ preparations for a challenging economic environment, where both secured and unsecured loans could result in greater losses. An analysis by the New York Fed revealed that Americans collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card issuance and delinquencies are also increasing as many individuals deplete their pandemic savings and increasingly rely on credit. According to TransUnion, credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter surpassing the trillion-dollar threshold. Furthermore, the commercial real estate sector remains particularly vulnerable.
“We’re still emerging from the COVID era, which affected banking and consumer health, primarily due to the stimulus measures that were implemented,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, potential problems for banks are anticipated in the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, indicated that the provisions reflected in any quarter may not accurately depict recent credit quality but instead represent banks’ expectations of future trends.
Interestingly, the system has shifted from one where increasing loan defaults raised provisions to one where macroeconomic forecasts largely dictate provisioning strategies, according to Narron.
Looking ahead, banks are anticipating slower economic growth, rising unemployment rates, and potential interest rate cuts later this year, which could lead to an increase in delinquencies and defaults.
Citi’s CFO Mark Mason highlighted that concerns are mainly concentrated among lower-income consumers, who have significantly reduced their savings since the pandemic. While the overall U.S. consumer remains resilient, Mason noted a significant disparity across income and credit score brackets. Only the highest-income quartile has maintained more savings than they had before the pandemic, while customers with lower FICO scores are witnessing declines in repayment rates.
The Federal Reserve continues to maintain interest rates at a 23-year high of 5.25-5.5%, pending stabilization of inflation metrics toward the bank’s target of 2% before any rate cuts.
Currently, despite banks preparing for potential defaults, the rate of defaults does not indicate an impending consumer crisis, according to Mulberry. He is particularly observing the differences between homeowners and renters from the pandemic period.
Despite rising interest rates, homeowners who secured low fixed rates on their debts are less affected compared to renters. With rents increasing by over 30% nationwide from 2019 to 2023 and grocery prices rising by 25%, renters without the benefit of locked-in rates are experiencing more financial strain.
Overall, the recent earnings reports reveal no new issues related to asset quality. Strong revenues, profits, and sustainable net interest income are positive indicators for the banking sector’s health.
“The banking sector shows resilience, and while this was somewhat anticipated, it is reassuring that the financial system remains sturdy. However, we must remain vigilant, as prolonged high-interest rates could lead to increased stress,” Mulberry concluded.