With interest rates at their highest levels in over 20 years and ongoing inflation impacting consumers, major banks are readying themselves for increased risks in their lending operations.
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 that banks set aside to mitigate potential losses from credit risks, which encompass overdue debts and loans, including those in commercial real estate.
JPMorgan reported a $3.05 billion provision for credit losses in the second quarter, while Bank of America recorded $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the quarter’s end, surging more than threefold from the previous quarter. Wells Fargo’s provisions amounted to $1.24 billion.
This buildup in reserves reflects banks’ concerns about a riskier lending environment, where both secured and unsecured loans could result in greater losses for leading financial institutions. The New York Federal Reserve recently analyzed household debt, revealing that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, credit card issuance and delinquency rates are climbing as many consumers deplete their pandemic-era savings and increasingly rely on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, 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 emerging from the COVID era, particularly regarding banking and consumer health, which was largely bolstered by the stimulus provided to consumers,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any potential issues for banks are anticipated in the coming months. “The provisions reported in any quarter don’t necessarily reflect credit quality from the last three months; they indicate what banks expect to encounter in the future,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
He further elaborated that the industry has transitioned from relying on rising provisions linked to poor loan performance to a model driven more by macroeconomic forecasts.
Looking ahead, banks foresee slowing economic growth, an increase in unemployment, and potential interest rate cuts in September and December, which could lead to higher delinquency and default rates by year-end.
Citi’s chief financial officer, Mark Mason, pointed out that warning signs are particularly evident among lower-income consumers, who have seen their savings diminish since the pandemic began. “While the overall U.S. consumer remains resilient, there is a notable divergence in performance across income and FICO score brackets,” Mason noted during a recent analyst call.
He observed that only the highest income quartile has managed to increase their savings since early 2019, and it is primarily consumers with FICO scores over 740 who are driving spending growth and maintaining timely payments. In contrast, those with lower FICO scores are experiencing significant drops in payment rates and are borrowing more due to the adverse effects of elevated inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high between 5.25% and 5.5%, awaiting stabilization in inflation metrics toward the central bank’s target of 2% before implementing expected rate cuts.
Even as banks brace for increased defaults in the latter part of the year, current default rates do not signal an imminent consumer crisis, according to Mulberry. He emphasizes the difference between homeowners and renters during the pandemic. “Yes, rates have risen substantially, but homeowners secured very low fixed rates on their debt during that time, so they aren’t feeling the pressure as acutely. Renters did not have that benefit.”
With rental prices climbing over 30% nationally from 2019 to 2023, and grocery costs increasing by 25%, renters who could not lock in lower rates and are facing rental costs that have outpaced wage growth are feeling the most financial strain.
Overall, the latest earnings report indicates that “there was nothing new this quarter in terms of asset quality,” according to Narron. Strong revenue, profits, and resilient net interest income are encouraging signs for the banking sector’s health.
“There’s some strength in the banking sector that may not have been totally anticipated, but it is reassuring to confirm that the financial system’s structures remain strong and sound at this time,” Mulberry commented. He cautioned that sustained high interest rates will continue to exert pressure on the sector.