With interest rates at their highest in over two decades and inflation putting pressure on 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 all increased their provisions for credit losses compared to the previous quarter. These provisions are the funds that banks set aside to cover potential losses from credit risk, including overdue debts and lending, such as commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter; Bank of America allocated $1.5 billion; Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, which more than tripled its prior reserve; while Wells Fargo designated $1.24 billion.
These significant reserves indicate that banks are preparing for a riskier lending environment, where both secured and unsecured loans could result in bigger losses for some of the largest financial institutions. According to recent analysis by the New York Fed, American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are on the rise, as consumers exhaust their pandemic-era savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter, marking the second consecutive quarter where total cardholder balances exceeded one trillion dollars, as reported by TransUnion. Meanwhile, commercial real estate remains vulnerable.
“We’re still emerging from the COVID period, and largely in banking and consumer health, it was driven by the stimulus provided to consumers,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
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 reflect recent credit quality but rather expectations for the future. He highlighted a shift in the system where macroeconomic forecasts now guide provisions rather than merely responding to overdue loans.
Looking ahead, banks predict slowing economic growth, rising unemployment rates, and potential interest rate cuts later this year, which could lead to increased delinquencies and defaults by year’s end.
Citi’s Chief Financial Officer Mark Mason pointed out that warnings are especially prevalent among lower-income consumers, who have seen their savings diminish since the pandemic started. “While we still see an overall resilient U.S. consumer, there’s a noticeable divergence in performance and behavior across different income levels,” Mason explained during a recent analyst call.
He also noted that only the highest income quartile has more savings than before 2019, with those having higher credit scores driving spending growth and maintaining high payment rates. Conversely, lower credit score individuals are experiencing a decline in payment rates and are borrowing more, heavily impacted by rising inflation and interest rates.
The Federal Reserve currently maintains interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation towards the central bank’s 2% target before implementing anticipated rate cuts.
While banks prepare for a potential rise in defaults later this year, Mulberry commented that current default rates do not indicate an imminent consumer crisis. He is particularly interested in the difference between homeowners and renters since the pandemic, noting that those who owned homes were able to lock in low fixed rates on their debts, shielding themselves from the current pain that renters face.
As rents surged over 30% nationwide and grocery prices rose by 25% from 2019 to 2023, renters without locked-in low rates are feeling increased financial strain.
Overall, the recent round of earnings reports did not uncover any new issues regarding asset quality, according to Narron. He remarked that strong revenues, profits, and a healthy net interest income suggest a still-robust banking sector.
“There’s resilience in the banking sector that might not have been entirely unexpected, but it is certainly reassuring to see that the structures of the financial system remain strong,” Mulberry concluded. “However, we are closely monitoring the situation; prolonged high interest rates inevitably introduce more stress.”