As interest rates reach levels not seen in over twenty years and inflation continues to impact consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, prominent banks including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo have augmented their provisions for credit losses compared to the previous quarter. This increase reflects the funds that these financial entities allocate to mitigate potential losses due to credit risks, including defaults on loans such as commercial real estate (CRE) financing.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, tripling its previous quarter’s reserve, and Wells Fargo reserved $1.24 billion.
These raised provisions indicate that banks are preparing for a more challenging economic landscape, where both secured and unsecured loans are likely to pose greater risks. An analysis from the New York Federal Reserve revealed that American households together owe approximately $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, credit card issuance and delinquency rates are trending upward as individuals exhaust their pandemic-era savings and increasingly rely on credit. Credit card balances climbed to $1.02 trillion in the first quarter, marking the second consecutive quarter that credit card balances have surpassed the trillion-dollar threshold, according to TransUnion. The CRE sector also remains vulnerable.
“We are still emerging from the COVID era, largely due to the stimulus measures that were implemented for consumers,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Anticipated challenges for banks are expected to manifest in the coming months.
“The provisions reported in any given quarter do not necessarily reflect the credit quality over the last three months; rather, they represent banks’ expectations for the future,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He added that there has been a shift in how provisioning works. Instead of increasing when loans begin to default, provisions are now often driven by macroeconomic forecasts.
In the short term, banks project a slowdown in economic growth, a rise in unemployment, and potential interest rate cuts later this year in September and December, according to Narron. This scenario could lead to more delinquencies and defaults as the year concludes.
Citi’s Chief Financial Officer Mark Mason pointed out that the concerns are particularly pronounced among lower-income consumers who have seen their savings decline since the pandemic began.
“While we continue to observe a generally resilient U.S. consumer, there is a noticeable divergence in performance and behavior across different levels of income and credit scores,” Mason noted during a recent call with analysts.
He observed that only the top income quartile has maintained higher savings compared to early 2019, with those holding credit scores over 740 driving growth in spending and upholding high payment rates. In contrast, lower credit score individuals are experiencing significant drops in payment rates and are borrowing more due to the intensified effects of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it awaits inflation measures to stabilize towards its 2% target before making any anticipated rate cuts.
Despite banks preparing for a potential increase in defaults later this year, Mulberry indicated that current defaults are not rising at a concerning pace that would suggest a consumer crisis. He remarked on the distinction between homeowners and renters during the pandemic.
“Although rates have surged, homeowners secured very low fixed rates on their debt and are not feeling the financial strain as acutely,” Mulberry explained. “Renters, on the other hand, did not benefit from that opportunity.”
With rents increasing over 30% nationwide and grocery costs rising by 25% between 2019 and 2023, those who have not locked in lower rates are experiencing significant financial pressure due to escalating rental prices outpacing wage growth.
Despite these challenges, the recent earnings report indicates that there were no significant changes in asset quality this quarter, according to Narron. Strong revenues, profits, and stable net interest income suggest a robust banking sector overall.
“There remains a notable strength in the banking sector, which is reassuring, as the structures of the financial system appear to be solid,” Mulberry noted. “However, we are closely monitoring the situation, as prolonged high interest rates could increase stress within the economy.”