As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for potential risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside by banks to cover anticipated losses from credit risks, which include bad debt and delinquent loans, particularly in the commercial real estate sector.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, more than triple its previous quarter’s build, and Wells Fargo’s provisions amounted to $1.24 billion.
These increased provisions indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans could lead to greater losses for some of the country’s largest financial institutions. A recent analysis by the New York Federal Reserve revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are climbing as individuals deplete their pandemic-era savings and increasingly turn to credit. In the first quarter, credit card balances hit $1.02 trillion, marking the second consecutive quarter that total balances surpassed the trillion-dollar mark, according to TransUnion. The commercial real estate sector also remains under significant pressure.
“We’re still emerging from the COVID era, and consumer health has largely been aided by government stimulus,” noted Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Challenges for banks are anticipated in the upcoming months. According to Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, the provisions reported by banks may not accurately reflect current credit quality but are instead indicative of future expectations.
“We have transitioned to a system where macroeconomic forecasts heavily influence provisioning, rather than just reporting on already delinquent loans,” Narron explained.
In the near future, banks are forecasting a slowdown in economic growth, a rise in unemployment, and two anticipated interest rate cuts later this year in September and December. This situation could lead to further delinquencies and defaults as the year concludes.
Citigroup’s chief financial officer, Mark Mason, indicated that current economic concerns are particularly concentrated among lower-income consumers, who have seen their savings decline since the pandemic.
“While the U.S. consumer remains largely resilient, there is a noticeable divergence in performance and behavior across different income and credit score levels,” Mason stated during a recent analyst call.
“Only the highest income quartile has increased their savings since early 2019, and it’s the customers with FICO scores above 740 who are driving spending growth and maintaining timely payments. In contrast, lower-scoring customers are experiencing a more significant decline in payment rates and increased borrowing, feeling the impact of elevated inflation and interest rates more acutely.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% while awaiting stabilization in inflation rates towards their 2% target before executing the anticipated rate cuts.
Despite banks bracing for a potential rise in defaults later this year, current default rates do not indicate an imminent consumer crisis, according to Mulberry. He is monitoring the distinction between those who were homeowners during the pandemic and those who were renters.
“Homeowners locked in low fixed rates and are not currently feeling the negative effects despite rising rates, whereas renters, who couldn’t take advantage of these rates, are facing challenges,” Mulberry noted.
With rents increasing by over 30% nationwide from 2019 to 2023 and grocery prices rising by 25% in the same period, renters who didn’t secure low rates are under significant financial strain, as their costs outpace wage growth.
For now, the major insights from the latest earnings reports indicate stability in asset quality, according to Narron. Strong revenues, profits, and resilient net interest income are positive signs for the banking sector.
“There is strength within the banking industry that may not have been entirely expected, providing reassurance that the financial system’s structures remain robust,” Mulberry remarked. “However, prolonged high interest rates will continue to impose stress on the sector.”