With interest rates hitting their highest levels in over two decades and inflation pressing heavily on consumers, major banks are bracing for increased risks associated with their lending practices.
During 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 amounts set aside by banks to cover potential losses linked to credit risks, including delinquent debts and commercial real estate loans.
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 reserves from the previous quarter, and Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans could result in larger losses for some of the biggest financial institutions. A recent analysis from the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as consumers exhaust their pandemic savings and turn increasingly to credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also remains vulnerable.
“We’re still recovering from the COVID era, particularly in the banking sector and consumer health, largely due to the stimulus that was extended to consumers,” remarked Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any difficulties for banks are anticipated to manifest in the coming months.
“The provisions reported in any given quarter do not necessarily reflect recent credit quality; rather, they indicate banks’ expectations for the future,” stated Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
He noted a shift from a historical model where rising provisions indicated failing loans to a more modern approach where macroeconomic forecasts drive provisioning strategies.
In the short term, banks are projecting a slowdown in economic growth, an increase in unemployment, and potential interest rate cuts later this year in September and December, which could lead to more delinquencies and defaults as the year comes to a close.
Citi’s chief financial officer, Mark Mason, highlighted that these warning signs are primarily observed among lower-income consumers, who have witnessed a depletion of savings since the pandemic.
“While the overall U.S. consumer remains resilient, performance varies significantly across different income levels and credit scores,” Mason explained during a recent earnings call. “Only the highest income quartile has managed to accumulate more savings compared to early 2019, while those in lower FICO brackets are experiencing decreased payment rates and increased borrowing due to the effects of high inflation and interest rates.”
The Federal Reserve currently maintains interest rates at a 23-year high of 5.25%-5.5%, awaiting stabilization in inflation measurements toward its 2% target before executing anticipated rate cuts.
Despite preparing for a rise in defaults later this year, the current default rates do not indicate an impending consumer crisis, according to Mulberry. He is particularly observing the contrast between homeowners and renters during the pandemic.
“While interest rates have increased significantly since that time, homeowners secured low fixed rates on their debts, leaving them less affected,” Mulberry noted. “Renters, on the other hand, have not had this opportunity.”
With rents increasing by over 30% nationwide between 2019 and 2023, and grocery prices rising by 25% during the same period, renters who didn’t lock in low rates are facing significant stress in their monthly budgets.
For now, however, the key takeaway from the recent earnings reports is that “there were no significant surprises this quarter in terms of asset quality,” concluded Narron. In fact, strong revenues, profits, and a stable net interest income continue to signal a resilient banking sector.
“There are positive signs within the banking sector that were somewhat unexpected, but it’s reassuring to know that the financial system remains robust,” Mulberry remarked. “As interest rates stay elevated, however, we remain vigilant as increased stress is likely.”