With interest rates at their highest in over 20 years and inflation continuing to impact consumers, major banks are preparing 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 from the previous quarter. These provisions represent funds that financial institutions set aside to cover potential losses from credit risk, including delinquent loans and bad debts, particularly in commercial real estate (CRE).
JPMorgan added $3.05 billion to its credit loss provisions in the second quarter, while Bank of America accumulated $1.5 billion. Citigroup’s allowance reached $21.8 billion by the end of the quarter, which more than tripled its previous quarter’s reserve increase, and Wells Fargo set aside $1.24 billion.
These accumulated reserves indicate that banks are bracing for a potentially riskier lending environment, where both secured and unsecured loans could lead to greater losses for some of the largest banks in the country. A recent analysis from the New York Fed revealed that American households now carry a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as people dip into the savings they accumulated during the pandemic and increasingly rely on credit. According to TransUnion, total credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that credit card balances exceeded the trillion-dollar threshold. Additionally, the CRE sector remains vulnerable.
“We’re still emerging from the COVID era, primarily due to the stimulus provided to consumers,” commented Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Any significant issues for the banks are expected to materialize in the coming months.
“The provisions reported for any quarter do not necessarily reflect the credit quality over the past three months, but rather what banks anticipate will occur in the future,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
He further emphasized a shift in the banking sector from a model where increased loan defaults would naturally lead to higher provisions, to one where macroeconomic forecasts are the primary drivers of these provisions.
Looking ahead, banks are anticipating slow economic growth, a rise in unemployment, and two interest rate cuts planned for September and December. This could result in more delinquencies and defaults as the year closes.
Citi’s chief financial officer Mark Mason pointed out that the warning signs are particularly evident among lower-income consumers, who are facing dwindling savings post-pandemic.
“While the overall U.S. consumer remains resilient, there are notable differences in performance and behavior based on income and credit scores,” Mason stated during a call with analysts. He noted that only the highest income quartile has increased their savings since early 2019, and that high-score customers are the primary drivers of spending growth, whereas those in lower credit brackets are struggling more, borrowing extensively and seeing a decline in their payment rates due to high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, waiting for inflation to approach its 2% target before enacting anticipated rate cuts.
Despite the banks’ preparations for a surge in defaults later this year, current default rates are not alarming enough to signal a consumer crisis, according to Mulberry. He is particularly interested in comparing the experiences of homeowners and renters during the pandemic.
“Interest rates have increased significantly, but homeowners locked in low fixed rates, so they are not feeling the financial pressure as much,” he noted. In comparison, renters, unable to secure low rates, are experiencing significant stress due to skyrocketing rents and rising grocery costs, which have increased over 30% and 25%, respectively, from 2019 to 2023.
For now, the major takeaway from the latest earnings reports is that “there were no significant changes in terms of asset quality this quarter,” Narron remarked. In fact, strong revenues, profits, and healthy net interest income reflect a robust banking sector.
“There’s a level of resilience in the banking industry that is somewhat reassuring, indicating that the foundations of the financial system remain strong,” Mulberry concluded. However, he warned that the prolonged high interest rates could exacerbate stress within the system.