As interest rates remain at their highest levels in over two decades and inflation continues to challenge consumers, major banks are gearing up to confront 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 set aside by financial institutions to mitigate potential losses from credit risks, including delinquent loans and issues related to commercial real estate (CRE) financing.
Specifically, JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance reached $21.8 billion at the end of the quarter, more than tripling its previous quarter’s reserves, and Wells Fargo’s provisions totaled $1.24 billion.
This buildup in reserves indicates that banks are preparing for a more challenging economic landscape, where both secured and unsecured loans may lead to greater losses. A recent study from the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, there is a marked increase in credit card issuance and, consequently, rising delinquency rates as consumers deplete their pandemic 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 $1 trillion, according to TransUnion. The commercial real estate sector remains vulnerable as well.
“We’re still emerging from the COVID era, and the overall health of the consumer owes much to the stimulus provided during that time,” stated Brian Mulberry from Zacks Investment Management.
However, the potential impact on banks is likely to materialize in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that current provisions do not necessarily reflect recent credit quality but rather what banks anticipate for the future.
“There’s an interesting shift; we’ve transitioned from a system where provisions increased as loans started to default to one where macroeconomic forecasts drive provisioning,” he explained.
In terms of immediate expectations, banks foresee slowing economic growth, rising unemployment, and two anticipated interest rate cuts in September and December. This could lead to an uptick in delinquencies and defaults by year-end.
Citi’s CFO Mark Mason indicated that potential troubles appear concentrated among lower-income consumers who have seen their savings diminish over the pandemic years. “While the overall U.S. consumer remains resilient, we are observing a divergence in performance based on FICO scores and income levels,” Mason remarked.
Higher-income clients appear to be thriving; only the top income quartile has more savings than at the start of 2019. It is primarily those with high FICO scores who are contributing to spending growth and maintaining strong payment rates, whereas those in lower FICO brackets face declining payment rates and increased borrowing due to the pressures of rising inflation and interest rates.
The Federal Reserve is maintaining interest rates at 5.25-5.5%, the highest levels in 23 years, awaiting stability in inflation before implementing expected rate cuts.
Currently, defaults are not rising rapidly enough to suggest an impending consumer crisis, according to Mulberry. He is particularly attentive to the differences between homeowners and renters during the pandemic. Homeowners secured low fixed-rate debt, shielding them from immediate pain, while renters, who did not benefit from such opportunities, are feeling the strain more acutely.
With rental prices surging over 30% and grocery costs escalating by 25% from 2019 to 2023, renters are experiencing significant budget pressures compared to their homeowner counterparts.
For the time being, the most significant takeaway from the recent earnings reports is that asset quality remains stable. Strong revenues, profits, and robust net interest income suggest that the banking sector continues to demonstrate resilience.
“There are positive signs within the banking sector that perhaps weren’t entirely expected, offering reassurance that the structure of the financial system remains robust,” Mulberry concluded. “However, we must remain vigilant; the longer interest rates are kept at this elevated level, the greater the stress they will generate.”