As interest rates reach their highest levels in over two decades and inflation continues to press 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 all raised their provisions for credit losses compared to the previous quarter. These provisions represent funds set aside by financial institutions to cover potential losses stemming from credit risk, including issues related to delinquent or bad debts and loans, particularly in commercial real estate.
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, more than tripling its reserve build from the previous quarter. Wells Fargo had provisions amounting to $1.24 billion.
The increased reserves signal that banks are preparing for a riskier environment, where both secured and unsecured loans may lead to greater losses. A recent analysis by the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
The trend in credit card issuance is rising, along with delinquency rates, as consumers deplete their pandemic-era savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where the total exceeded one trillion dollars, according to TransUnion. Additionally, the commercial real estate sector remains vulnerable.
“We’re still recovering from the COVID era, and a lot of this is tied to the stimulus that was provided to consumers,” commented Brian Mulberry, a portfolio manager at Zacks Investment Management.
However, challenges for banks are anticipated in the upcoming months.
“The provisions noted in any given quarter don’t necessarily reflect credit quality for the last three months; rather, they indicate what banks anticipate for the future,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
He noted a shift from a historical approach where bad loans led to increased provisions, to a framework where macroeconomic forecasts drive provisioning decisions.
In the near term, banks expect slower economic growth, rising unemployment, and potential interest rate cuts later in the year, which could lead to more delinquencies and defaults by year’s end.
Citigroup’s chief financial officer Mark Mason pointed out that warning signs are particularly prevalent among lower-income consumers who have seen their savings diminish post-pandemic.
“While the overall U.S. consumer remains resilient, we are noticing a divergence in behavior based on FICO scores and income levels,” Mason stated in a call with analysts. “Only the top income quartile has maintained higher savings since early 2019, and it is mainly those with FICO scores over 740 driving spending growth and high payment rates. Conversely, those with lower scores are experiencing significant drops in payment rates and are borrowing more, being more affected by high inflation and rates.”
The Federal Reserve has kept interest rates at a 23-year high, waiting for inflation to stabilize toward its 2% target before considering anticipated rate cuts.
Despite banks preparing for a surge in defaults later this year, current default rates do not yet indicate a consumer crisis, according to Mulberry. He is particularly focused on the contrast between homeowners and renters during the pandemic.
“Although rates have significantly increased, homeowners locked in low fixed rates and are largely shielded from the current pressures. Renters, however, missed this opportunity,” Mulberry explained. “With rents rising over 30% nationally from 2019 to 2023 and grocery costs climbing 25%, renters who did not secure low rates face the most budgetary stress.”
For the time being, the recent earnings reports indicate that there were no significant asset quality changes this quarter. The banking sector remains marked by strong revenues, profits, and resilient net interest income.
“There is a strength in the banking sector that may not have been entirely unexpected, but it is reassuring to confirm the robustness of the financial system at this time,” Mulberry remarked. “Nevertheless, as long as interest rates remain elevated, the stress will continue to mount.”