As interest rates remain at their highest levels in over 20 years and inflation continues to impact consumers, major banks are bracing for increased risks related to their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions represent funds set aside by financial institutions to cover potential losses from credit risks, including delinquent loans and bad debts, particularly in commercial real estate lending.
JPMorgan set aside $3.05 billion for credit losses in the last quarter, while Bank of America allocated $1.5 billion. Citigroup reported an allowance for credit losses of $21.8 billion, more than tripling its reserves from the previous quarter, and Wells Fargo added $1.24 billion.
This buildup in reserves indicates that banks are preparing for a more challenging environment where both secured and unsecured loans could lead to larger losses for these financial institutions. A recent analysis from the New York Federal Reserve highlighted that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as consumers exhaust their pandemic-era savings and rely more on credit. Credit card balances reached $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 is also in a vulnerable position.
Banking expert Brian Mulberry of Zacks Investment Management noted that we are still recovering from the impacts of COVID-19, emphasizing the role of government stimulus in supporting consumer financial health. However, any challenges for banks may arise in the coming months.
Mark Narron, a senior director at Fitch Ratings, explained that quarterly provisions do not solely reflect recent credit quality but rather banks’ expectations for future conditions. This shift means that economic forecasts increasingly influence provisioning practices.
In the short term, banks are anticipating slower economic growth, rising unemployment, and two interest rate cuts later this year in September and December, which could lead to increased delinquency rates and defaults as the year concludes.
Citi’s Chief Financial Officer Mark Mason pointed out that economic red flags are particularly concentrated among lower-income consumers, who have seen their savings diminish since the pandemic. He noted that while the overall U.S. consumer remains resilient, performance varies significantly across different income brackets and credit scores.
Currently, only the top income quartile holds more savings than they did at the start of 2019, and it is the consumers with FICO scores above 740 who are driving spending growth and maintaining high payment rates. In contrast, consumers in lower FICO brackets are experiencing sharp declines in payment rates and are borrowing more heavily as they are more severely affected by high inflation and interest rates.
The Federal Reserve has maintained interest rates at between 5.25% and 5.5%, the highest level in 23 years, while waiting for inflation metrics to stabilize towards the central bank’s target of 2% before implementing expected rate cuts.
Despite banks’ preparations for higher default rates in the later part of the year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He is particularly monitoring the differences between homeowners and renters from the pandemic era. Homeowners, having locked in low fixed-rate mortgages, do not feel the same financial strain as renters, who face rising rental costs without the benefit of low rates.
With rent prices having increased by over 30% and grocery costs rising by 25% from 2019 to 2023, renters are experiencing the most financial pressure as their expenses surpass wage growth.
Overall, the latest earnings reports show no significant changes in asset quality. Instead, strong revenues, profits, and a stable net interest income highlight the continued health of the banking sector. Mulberry remarked that while some strengths are present in the banking industry, prolonged high interest rates could introduce further stress.