As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are preparing for increased risks associated with their lending practices.
In the second quarter, prominent banks like JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their provisions for credit losses compared to the previous quarter. These provisions represent the funds that financial institutions set aside to cover potential losses related to credit risks, which include delinquent or bad debt as well as loans such as commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter; Bank of America allocated $1.5 billion; Citigroup’s credit loss allowance reached $21.8 billion by the end of the quarter, more than tripling its reserves from the previous quarter; and Wells Fargo had provisions totaling $1.24 billion.
These increased provisions indicate that banks are preparing for what could be a riskier lending environment, where both secured and unsecured loans might lead to greater losses for some of the country’s biggest financial institutions. A recent analysis from the New York Fed revealed that Americans owe a total of $17.7 trillion across consumer loans, student loans, and mortgages.
The issuance of credit cards and subsequent delinquency rates are also climbing as individuals exhaust their pandemic-era savings and turn more to credit. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances exceeded the trillion-dollar mark. Commercial real estate also remains in a vulnerable position.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted the ongoing impacts of the COVID-19 era, particularly the effects of substantial consumer stimulus.
However, any issues banks might face are expected to surface in the coming months.
Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, explained that the provisions recorded in any quarter do not necessarily reflect credit quality from the last three months but are indicative of banks’ expectations for the future.
He also pointed out a shift in the banking landscape: rather than provisions responding solely to rising bad loans, macroeconomic forecasts increasingly influence these financial decisions.
In the short term, banks foresee slowing economic growth, a higher unemployment rate, and two anticipated interest rate cuts later this year in September and December, which could result in more delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, emphasized that warning signs are particularly evident among lower-income consumers, who have seen a decline in their savings following the pandemic.
Despite observing overall resilience among U.S. consumers, Mason highlighted a growing disparity in financial behavior across different income levels. He noted that only the highest income quartile has managed to increase their savings since early 2019, with those in higher FICO score brackets driving spending growth while lower FICO band customers face significant declines in payment rates, impacted by rising 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 measures toward the central bank’s 2% target before initiating expected rate cuts.
Though banks brace for a wave of defaults later in the year, current default rates do not yet suggest an impending consumer crisis. Mulberry noted the cleft between those who owned homes during the pandemic and renters, stating that homeowners locked in low fixed rates, while renters missed out on that opportunity.
With rents rising over 30% nationwide between 2019 and 2023 and grocery costs increasing by 25%, renters who have not benefited from low rates are now facing financial strain, as their rental expenses surge beyond wage growth.
Currently, analysts comment that recent earnings show no new concerns regarding asset quality. Strong revenues, profits, and net interest income indicate a banking sector that remains relatively healthy.
Mulberry acknowledged that the banking sector continues to show strength, which is somewhat reassuring, asserting that the financial system’s structure appears solid at this moment. Nonetheless, he cautioned that prolonged high interest rates could escalate stress levels in the future.