With interest rates reaching two-decade highs and inflation continuing to impact 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 all increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks set aside to cover potential losses from credit risks, including delinquent accounts and risky lending areas such as commercial real estate.
JPMorgan allocated $3.05 billion for credit losses, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, more than tripling its reserves from the prior quarter, and Wells Fargo recorded provisions of $1.24 billion.
These increased provisions indicate that banks are preparing for a riskier environment, where both secured and unsecured loans may lead to larger losses for some of the biggest financial institutions. An analysis by the New York Federal Reserve revealed that total household debt now stands at $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are climbing as consumers deplete pandemic-era savings and increasingly turn to credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total cardholder balances surpassed the trillion-dollar mark, according to TransUnion. The commercial real estate sector also remains vulnerable.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking landscape is still recovering from the COVID-19 era, significantly influenced by stimulus measures aimed at consumers.
The challenges for banks are anticipated in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that current provisions don’t solely reflect credit quality from recent months but rather banks’ expectations for future conditions.
He specified that the banking sector has transitioned from relying on historical performance indicators to a system where macroeconomic forecasts drive provisioning decisions.
In the short term, banks are expecting slowing economic growth, a potential rise in unemployment, and two interest rate cuts scheduled for September and December, which could lead to increased delinquencies and defaults by year-end.
Citi’s chief financial officer, Mark Mason, indicated that concerns are particularly evident among lower-income consumers, who have seen their savings decrease significantly since the pandemic began.
“While the overall U.S. consumer appears resilient, we observe notable disparities in performance based on income and credit scores,” he explained during an analyst call.
Mason added that only the highest income quartile has managed to save more than they did at the beginning of 2019, and it is consumers with FICO scores over 740 who are driving spending growth and maintaining timely payments. In contrast, those with lower credit scores are experiencing sharp declines in payment rates and are borrowing more amidst high inflation and rising interest rates.
The Federal Reserve has sustained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation towards the central bank’s 2% target before implementing anticipated rate cuts.
Despite banks bracing for potential defaults later in the year, Mulberry noted that defaults are not yet rising at a rate indicative of a consumer crisis. He highlighted the difference between homeowners and renters during the pandemic. Homeowners, having secured low fixed rates on their debt, are less affected by current rate increases, while renters face significant challenges.
With national rent prices climbing over 30% and grocery costs rising 25% from 2019 to 2023, renters, especially those unable to lock in lower rates, are struggling more with their monthly budgets.
For now, analysts highlight that the latest earnings reports show stability within the banking sector, with no significant changes in asset quality. Strong revenues, profits, and resilient net interest income reflect a healthy banking environment.
“There is some strength in the banking sector that might have been unexpected, but it is reassuring to conclude that the financial system remains robust and sound at this point,” Mulberry stated. “However, we are closely monitoring the situation, as prolonged high-interest rates will continue to exert stress on the system.”