As interest rates reach more than two-decade highs and inflation continues to pressure consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their provisions for credit losses compared to the previous quarter. These provisions represent the funds allocated by financial institutions to cover potential losses from credit risks, which include bad debts and delinquent loans, particularly in sectors like commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses; Bank of America reserved $1.5 billion; Citigroup’s provision reached $21.8 billion, more than tripling its previous quarterly reserves; and Wells Fargo allocated $1.24 billion for the same purpose.
These increased reserves indicate that banks are preparing for a riskier environment, where both secured and unsecured loans may incur larger losses. A recent analysis by the New York Federal Reserve reported that Americans carry a collective debt of $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and associated delinquency rates are climbing as individuals deplete their pandemic-era savings and increasingly rely on credit. Credit card balances surpassed $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances exceeded a trillion dollars, according to TransUnion. The commercial real estate sector also continues to face significant challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the lingering effects of the COVID era, particularly the stimulus provided to consumers, have played a major role in the current banking landscape.
Issues for banks are expected to manifest in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, emphasized that a bank’s provisions for credit losses are more indicative of future expectations rather than current credit quality.
“The provisions that you see at any given quarter don’t necessarily reflect credit quality for the last three months; they reflect what banks expect to happen in the future,” he said.
Banks are forecasting slower economic growth, higher unemployment, and two anticipated interest rate cuts later this year in September and December. These factors could lead to an increase in delinquencies and defaults as the year progresses.
Citi’s chief financial officer Mark Mason highlighted that warning signs are particularly evident among lower-income consumers, who have seen their savings diminish since the pandemic.
“While we continue to see an overall resilient U.S. consumer, we also continue to see a divergence in performance and behavior across FICO and income bands,” Mason stated during a recent analyst call.
Only the highest-income quartile has maintained greater savings compared to early 2019, with affluent customers driving spending growth and consistent payment rates. Conversely, those in lower FICO score brackets are facing reduced payment rates and are increasingly borrowing, affected more severely by high inflation and interest rates.
The Federal Reserve’s interest rates currently stand at a 23-year high of 5.25-5.5%, awaiting stability in inflation measures towards the central bank’s 2% target before implementing expected rate cuts.
Despite preparations for an uptick in defaults in the latter half of the year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He remains attentive to the contrasts between homeowners who secured low fixed-rate mortgages during the pandemic and renters.
“Yes, rates have gone up substantially since then, but homeowners locked in very low fixed rates on all of that debt, and so they’re still really not feeling the pain, if you will,” Mulberry noted. “If you were renting during that period of time, you didn’t get that opportunity.”
With rents surging more than 30% nationwide from 2019 to 2023 and grocery prices rising 25% in the same timeframe, renters who missed out on low rates are experiencing heightened financial strain.
For now, key insights from the latest earnings reports suggest that “there was nothing new this quarter in terms of asset quality,” Narron remarked. Strong revenues, profits, and resilient net interest income all signal a still-healthy banking sector.
“There’s some strength in the banking sector that I don’t know was totally unexpected, but it’s certainly a relief to say that the structures of the financial system are still very strong and sound at this point in time,” Mulberry concluded. However, he cautioned that prolonged high-interest rates could continue to inflict stress on consumers and the industry.