As interest rates remain at their highest level in over 20 years and inflation continues to affect consumers, major banks are gearing up for 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 prior quarter. These provisions represent funds set aside by financial institutions to cover potential losses from credit risks, such as delinquent debts and lending vulnerabilities, including those tied to commercial real estate (CRE) loans.
Specifically, JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, marking a significant increase compared to previous quarters. Meanwhile, Wells Fargo’s provisions totaled $1.24 billion.
These increased reserves indicate that banks are anticipating a more challenging lending environment, where both secured and unsecured loans could lead to larger losses. A recent analysis by the New York Federal Reserve revealed that American households collectively owe $17.7 trillion in various forms of debt, including consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as individuals deplete their pandemic-era savings and turn to credit for financial support. Credit card balances hit $1.02 trillion in the first quarter of this year, surpassing the trillion-dollar mark for the second consecutive quarter, as reported by TransUnion. The commercial real estate sector also remains in a vulnerable state.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that although the financial system is recovering from the COVID era, stimulated consumer spending continues to underpin bank health.
However, challenges for banks are expected to emerge in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, emphasized that the credit provisions reported by banks reflect their future expectations rather than just recent credit quality.
Currently, banks are predicting slowing economic growth, an increase in unemployment rates, and possible interest rate cuts in September and December, which could lead to a rise in delinquencies and defaults as the year ends.
Citigroup’s chief financial officer, Mark Mason, pointed out that these concerning trends primarily affect lower-income consumers, who have seen their savings diminish since the pandemic began. He noted that while the overall U.S. consumer remains resilient, there is a noticeable disparity in performance and behavior based on income levels and FICO scores.
Mason explained that only the highest-income quartile has maintained savings levels above those recorded in 2019, with customers boasting FICO scores above 740 leading spending growth and high payment rates. Conversely, customers in lower FICO bands are experiencing decreases in payment rates and increasing borrowing due to the pressures of rising inflation and interest rates.
The Federal Reserve has kept interest rates at a range of 5.25% to 5.5%, the highest in 23 years, as officials await stabilization in inflation metrics to reach a target of 2% before implementing anticipated rate cuts.
Despite banks bracing for potential defaults later this year, they have not reported a concerning rise in default rates that would indicate a full-blown consumer crisis, as noted by Mulberry. He highlighted the contrast between homeowners and renters during this period, indicating that homeowners, who secured low fixed rates, are less impacted by rising rates compared to renters facing skyrocketing rental costs.
Between 2019 and 2023, rents have risen over 30%, and grocery prices have surged by 25%. Renters, who did not benefit from low-rate opportunities, are experiencing heightened stress with their monthly budgets.
For now, industry analysts conclude that there are no alarming new issues regarding asset quality from the latest earnings reports. Strong revenues, profits, and resilient net interest income reflect a still-robust banking sector. Mulberry stressed that while the financial system appears strong, prolonged high interest rates may induce additional stress in the future.