With interest rates reaching their highest levels in over two decades and inflation affecting 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 significantly increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds set aside by financial institutions to cover potential losses from credit risk, including overdue debts and bad loans, particularly in commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses soared to $21.8 billion by the end of the quarter, more than tripling from the prior quarter, and Wells Fargo recorded provisions of $1.24 billion.
These provisions indicate that banks are bracing for a more challenging environment, as both secured and unsecured loans could result in larger losses for these major financial institutions. Recent analysis by the New York Federal Reserve revealed that U.S. households currently owe a staggering $17.7 trillion in consumer debt, student loans, and mortgages.
Moreover, the issuance of credit cards and associated delinquency rates are rising, as many individuals deplete their pandemic-era savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where total balances exceeded the trillion-dollar threshold, according to TransUnion. Additionally, commercial real estate remains in a fragile position.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented, “We’re still emerging from the COVID era, and notably in banking and consumer health, the stimulus deployed to consumers played a significant role.”
However, challenges for banks are expected to manifest in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that provisions recorded in any given quarter do not necessarily reflect recent credit quality but rather the banks’ expectations for the future.
“It’s interesting to see how we’ve transitioned from a system where provisions increased as loans deteriorated to one where macroeconomic forecasts drive these decisions,” Narron stated.
Looking ahead, banks anticipate slower economic growth, a rise in unemployment, and potential interest rate cuts later in the year, which could lead to increased delinquencies and defaults as 2023 comes to a close.
Citi’s chief financial officer, Mark Mason, pointed out that concerning trends appear to be particularly evident among lower-income consumers, whose savings have diminished since the pandemic. “While the overall U.S. consumer remains resilient, we observe a noticeable divergence in performance across different income levels,” he remarked.
He further elaborated that only the highest income quartile has managed to retain more savings compared to early 2019, with those in the over-740 FICO score category driving spending growth and maintaining high payment rates. In contrast, consumers in lower FICO brackets are experiencing more significant declines in payment rates and accruing more debt due to heightened inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting a stabilization of inflation rates toward its 2% target before considering anticipated rate cuts.
Despite preparations for a potential increase in defaults in the latter half of the year, actual default rates have not surged to levels indicative of a consumer crisis just yet, according to Mulberry. He observes a difference in financial impacts between homeowners and renters during this period.
“Though rates have surged, homeowners locked in low fixed rates before this took effect, so they aren’t feeling the pressure as much. Renters, however, have not had that opportunity,” he explained.
With national rent prices rising over 30% from 2019 to 2023 and grocery costs increasing by 25% in the same timeframe, renters unable to secure low rates are experiencing the greatest strain on their budgets.
For now, the major takeaway from the latest earnings reports is that there have been no significant changes in asset quality during this quarter. Strong revenues, profits, and robust net interest income are all encouraging signs of a stable banking sector.
“There’s a resilience in the banking sector that was perhaps not entirely unexpected, but it is reassuring to confirm that the foundations of the financial system remain sound at this time,” Mulberry added. “However, we remain vigilant; prolonged high interest rates will inevitably cause more strain.”