With interest rates reaching levels not seen in over 20 years and inflation impacting consumers, major banks are gearing up to confront heightened 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 are funds that banks reserve to mitigate potential losses from credit risk, including bad debt and lending, especially concerning commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses surged to $21.8 billion by the end of the quarter, marking more than a threefold increase from the previous quarter, and Wells Fargo reported provisions of $1.24 billion.
These increased reserves reflect banks’ anticipation of a riskier lending environment, where both secured and unsecured loans could lead to more significant losses. According to a recent report by the New York Federal Reserve, total household debt in the U.S. stands at approximately $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
The issuance of credit cards and delinquency rates are also climbing as individuals exhaust their pandemic-era savings and increasingly rely on credit. The total credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that these balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector is also facing challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector is still recovering from the COVID-19 pandemic largely due to the stimulus measures that were implemented.
However, issues for banks may arise in the forthcoming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, explained that current provisions do not necessarily correlate with credit quality observed in the last three months but rather indicate what banks expect for the future.
He said that the banking industry has shifted from a past where loan defaults prompted increased provisions, to one where macroeconomic forecasts are the primary drivers for provisioning.
In the near term, banks anticipate slower economic growth, a rise in unemployment, and two interest rate cuts scheduled for September and December, which could contribute to increased delinquencies and defaults.
Citi’s Chief Financial Officer Mark Mason highlighted emerging concerns among lower-income consumers, who have experienced dwindling savings since the pandemic began.
“While the U.S. consumer remains resilient overall, there is a noticeable divergence in performance based on credit scores and income levels,” Mason stated in a call with analysts. He pointed out that only consumers in the highest income quartile have managed to increase their savings since early 2019, with those maintaining high payment rates linked to higher FICO scores. In contrast, customers with lower FICO scores are borrowing more and seeing declines in payment rates, largely due to the impact of rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high, ranging from 5.25% to 5.5%, as it monitors inflation trends in relation to its 2% target before implementing any anticipated rate cuts.
Despite banks preparing for a potential rise in defaults later in the year, Mulberry noted that defaults have not yet surged to levels indicative of a consumer crisis. He is particularly observing the differences between homeowners and renters during this period.
While interest rates have significantly increased, homeowners locked in low fixed rates for their debts and are not feeling the same financial pressure as renters. Renters, who have faced rental prices that have risen over 30% from 2019 to 2023 and grocery costs up 25% in the same timeframe, are experiencing greater financial strain, as their budgets are less able to accommodate these increases.
Currently, the most notable message from the recent earnings reports is that there were no significant developments concerning asset quality during the quarter. Strong revenue, profits, and resilient net interest income indicate that the banking sector remains robust.
Mulberry indicated that while there are encouraging signs within the banking industry, sustained high interest rates could lead to increased stress over time.