As interest rates reach peaks not seen in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, prominent financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their credit loss provisions compared to the previous quarter. These provisions are funds set aside by banks to cover potential losses stemming from credit risks, including defaults on loans and delinquent debt, particularly in the commercial real estate sector.
JPMorgan set aside $3.05 billion for credit losses in the second quarter; Bank of America allocated $1.5 billion; Citigroup raised its allowance for credit losses to $21.8 billion, more than triple its reserves from the previous quarter; and Wells Fargo reserved $1.24 billion.
These precautionary measures signal that banks are preparing for a riskier landscape, where both secured and unsecured loans could result in greater losses. A recent report by the New York Federal Reserve highlighted that U.S. households are carrying a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, the issuance of credit cards and corresponding delinquency rates are climbing as pandemic-era savings diminish, forcing consumers to rely more heavily on credit. In the first quarter, credit card balances soared to $1.02 trillion, marking the second consecutive quarter where the total exceeded a trillion dollars, according to TransUnion. The commercial real estate sector continues to face significant challenges as well.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted the lingering effects of the COVID era on banking and consumer health, largely due to the stimulus funds administered during that time.
Looking ahead, banks expect challenges to emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions recorded each quarter reflect not just past credit quality but banks’ future expectations.
He added that the current environment has shifted from traditional practices where bad loans increased provisions to one where macroeconomic forecasts predominantly drive provisioning strategies.
Banks are predicting slower economic growth, a rise in unemployment rates, and potential interest rate cuts later this year, which could lead to an uptick in delinquencies and defaults.
Citigroup’s CFO Mark Mason highlighted that the most concerning indicators are emerging among lower-income consumers, whose savings have eroded since the pandemic. He remarked that while the overall U.S. consumer remains resilient, disparities exist based on income and credit scores.
According to Mason, the top income quartile has seen savings increase since early 2019, and those with FICO scores above 740 are leading spending growth and maintaining high payment rates. In contrast, customers with lower credit scores are exhibiting declining payment rates and higher borrowing, feeling the crunch from rising inflation and interest rates.
Despite banks preparing for potential defaults in the latter half of the year, current default rates do not yet suggest a widespread consumer crisis, as noted by Mulberry. He is particularly observing the differences between homeowners, who benefitted from low fixed rates, and renters affected by skyrocketing rental prices.
With rental costs rising over 30% from 2019 to 2023 and grocery prices increasing by 25%, renters are experiencing significant budget pressures, according to Mulberry.
In summary, the latest earnings reports indicated stability in asset quality for the banking sector, with strong revenue and profits, suggesting that the financial system remains robust. Mulberry stated that while there is notable strength within the banking industry, prolonged high interest rates could introduce additional stress in the future.