With interest rates at their highest level in over two decades and inflation putting pressure on consumers, major banks are gearing up to deal with 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 compared to the previous quarter. These provisions are set aside by financial institutions to mitigate potential losses from credit risks, including issues with delinquent loans and commercial real estate (CRE) lending.
JPMorgan raised its provision for credit losses by $3.05 billion in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, significantly more than the previous quarter, and Wells Fargo’s provisions totaled $1.24 billion.
These increased provisions indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans could result in greater losses. A recent assessment from the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, credit card issuance and delinquency rates are rising as individuals deplete their pandemic-era savings and increasingly depend 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 surpassed the trillion-dollar threshold, according to TransUnion. Meanwhile, the CRE sector also remains vulnerable.
“We’re still emerging from the COVID era, particularly regarding banking and consumer health, which has relied heavily on the stimulus provided to consumers,” remarked Brian Mulberry, client portfolio manager at Zacks Investment Management.
However, banks might face more significant challenges in the upcoming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, explained that the provisions seen in any quarter reflect banks’ expectations for future conditions, rather than just past credit quality.
“With the shift from a system where loan performance dictated provisioning to one now driven by macroeconomic forecasts, it’s notable,” Narron noted.
Currently, banks anticipate slowing economic growth, a higher unemployment rate, and two interest rate cuts later this year in September and December, suggesting the possibility of increased delinquencies and defaults.
Citi’s Chief Financial Officer Mark Mason indicated that the emerging risks are mainly affecting lower-income consumers, who have experienced a decline in savings post-pandemic.
“While the overall U.S. consumer appears resilient, we see varied performance across different income levels,” Mason stated during a recent analyst call. He highlighted that only the highest income quartile has managed to increase their savings since early 2019, with consumers in higher FICO score bands driving spending and maintaining good payment rates. In contrast, consumers with lower FICO scores are witnessing declines in payment rates and are increasingly borrowing due to the pressures of high inflation and interest rates.
The Federal Reserve continues to maintain interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation metrics toward the central bank’s 2% target before implementing anticipated rate cuts.
Although banks are bracing for a potential increase in defaults later this year, current trends do not yet signal a consumer crisis, according to Mulberry. He is particularly concerned about the distinction between homeowners and renters during the pandemic.
“While rates have significantly increased, homeowners were able to lock in low fixed rates, so they aren’t feeling the squeeze as much,” Mulberry explained, contrasting their situation with that of renters, who have faced sharp rent increases and rising living costs.
Rental prices have surged over 30% nationwide between 2019 and 2023, alongside a 25% rise in grocery costs during the same timeframe. Renters who did not secure low rates are struggling the most in their budgets.
In summary, the latest earnings reports indicate there have been no significant changes in asset quality. Strong revenues, profits, and healthy net interest income continue to reflect the stability of the banking sector.
“There’s a robustness in the banking sector that is somewhat reassuring. While not entirely unexpected, it is a relief to confirm that the structures within the financial system remain robust and sound,” Mulberry stated. However, he warned that sustained high interest rates could lead to increased financial strain.