As interest rates peak at levels not seen in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter of the year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions represent the amounts banks set aside to offset potential losses from credit risks, such as bad debt and delinquent loans, including those related to commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance reached $21.8 billion at the end of the quarter, indicating a significant increase from previous reserves, and Wells Fargo’s provisions amounted to $1.24 billion.
These enhanced reserves suggest that banks are preparing for a challenging financial environment, with both secured and unsecured lending posing increased risks. According to the New York Fed, American households collectively owe $17.7 trillion in consumer, student, and mortgage loans.
Moreover, credit card issuance is growing, as are delinquency rates, driven by dwindling pandemic-era savings and increased reliance on credit. The total credit card debt reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that balances exceeded this threshold, as reported by TransUnion. Meanwhile, CRE remains in a vulnerable position.
“We are still transitioning from the pandemic period, particularly regarding banking and consumer health, influenced heavily by the prior stimulus measures,” commented Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, challenges for banks are expected in the forthcoming months. “The provisions reported in any quarter do not necessarily mirror the credit quality experienced over the last three months; they instead reflect banks’ expectations for future events,” noted Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He pointed out a noteworthy shift in the banking system where macroeconomic forecasts now influence provisioning more than the traditional model of provisioning based on bad loans.
In the near future, banks anticipate slower economic growth, a rise in unemployment, and two potential interest rate cuts later this year, which may lead to an increase in delinquencies and defaults as the year progresses.
Citi’s chief financial officer Mark Mason highlighted concerning trends primarily among lower-income consumers who are experiencing squeezed savings in the aftermath of the pandemic. “While the overall U.S. consumer remains resilient, we see a divergence in performance based on income levels,” he explained during an analyst call.
Mason further observed that only the highest-income quartile had managed to retain more savings than they had in early 2019, with higher credit score customers driving expenditure growth and sustaining higher payment rates. Conversely, those in lower credit score brackets are witnessing declines in payment rates while increasingly borrowing amidst high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high, ranging between 5.25% and 5.5%, while waiting for inflation rates to stabilize around its 2% target before implementing anticipated rate reductions.
Despite banks gearing up for greater defaults in the later part of the year, Mulberry noted that defaults have not yet escalated to levels indicating a consumer crisis. He emphasized the differentiation in experiences between current homeowners and renters during the pandemic. Homeowners, having locked in low fixed rates on their mortgages, haven’t felt the impact as severely, while renters have been struggling with soaring rent prices.
Between 2019 and 2023, rental costs increased by over 30%, and grocery prices rose by 25%, placing added financial strain on renters who did not benefit from favorable mortgage rates.
Overall, the latest earnings reports reveal no significant changes in asset quality, according to Narron. The banking sector continues to demonstrate strong revenues, profits, and healthy net interest income, indicating a resilient financial landscape.
“There is resilience within the banking sector that may not have been entirely anticipated, but it’s comforting to know that the structural integrity of the financial system remains robust for now,” Mulberry stated. He cautioned, however, that prolonged high-interest rates could cause further stress in the future.