As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks in their lending practices.
In the second quarter, some of the largest banks, including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo, reported a rise in their provisions for credit losses compared to the previous quarter. These provisions reflect the funds that banks set aside to cover potential losses from credit risks, such as bad debts and commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses; Bank of America reported $1.5 billion; Citigroup’s allowance reached $21.8 billion—more than tripling its build from the previous quarter; and Wells Fargo reported provisions of $1.24 billion.
This accumulation indicates that banks are preparing for a challenging financial environment, where both secured and unsecured loans may result in increased losses for some of the nation’s leading financial institutions. A recent analysis revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, credit card issuance and delinquency rates are on the rise as pandemic-era savings dwindle and reliance on credit increases. In the first quarter this year, credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. The commercial real estate sector also faces significant challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the situation. He noted that the ongoing effects of the COVID-19 pandemic and the related stimulus measures are still impacting banking and consumer health.
However, any real issues for banks are anticipated in the months ahead. Mark Narron, senior director in Fitch Ratings’ Financial Institutions Group, explained that the provisions seen each quarter are not a reflection of past credit quality but rather banks’ expectations for the future.
Currently, banks anticipate slowing economic growth, a rising unemployment rate, and potential interest rate cuts later this year, which could lead to more delinquencies and defaults as 2023 progresses.
Citigroup’s Chief Financial Officer Mark Mason pointed out that the emerging concerns appear to be particularly focused on lower-income consumers, who have seen their savings decrease since the pandemic began.
While the overall U.S. consumer remains resilient, Mason indicated a divergence in performance and behavior across different income levels and credit scores. He mentioned that only the top income quartile has more savings now compared to early 2019, while those in lower FICO score brackets are experiencing declines in payment rates and increasing borrowing, driven by high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation towards its 2% target before considering rate cuts.
Despite the banks’ preparations for increased defaults later in the year, Mulberry emphasized that defaults have not yet escalated to a level indicative of a consumer crisis. He noted the difference in experiences between homeowners and renters, highlighting that homeowners with fixed-rate mortgages are not feeling the pinch as acutely as renters facing soaring rental prices.
Mulberry pointed out that rents have risen over 30% nationwide from 2019 to 2023, while grocery prices have surged by 25% in the same timeframe. Renters, without the advantage of locked-in low rates, are experiencing the greatest strain on their monthly budgets.
For now, the key takeaway from the latest earnings reports is that asset quality remains stable. Narron noted robust revenues, profits, and healthy net interest income as positive signs for the banking sector. Mulberry concluded that, despite some strengths, prolonged high-interest rates are a growing concern that requires close monitoring.