With interest rates at their highest in over 20 years and inflation affecting consumers, major banks are bracing for potential risks in 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 represent funds that banks allocate to cover possible losses due to credit risks, which include delinquent or bad debts and loans, particularly in the commercial real estate sector.
JPMorgan set aside $3.05 billion for credit losses, while Bank of America allocated $1.5 billion. Citigroup’s credit loss allowance reached $21.8 billion, more than tripling its reserves from the prior quarter, and Wells Fargo recorded $1.24 billion in provisions.
These increased reserves indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans may result in larger losses. A recent analysis from the New York Fed revealed that American households hold a collective debt of $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise as consumers increasingly rely on credit to cope with dwindling pandemic savings. In the first quarter of this year, credit card balances surpassed $1.02 trillion, marking the second consecutive quarter where totals exceeded this threshold, according to TransUnion. Moreover, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking landscape and consumer health are still affected by the post-COVID environment, particularly due to the stimulus programs previously rolled out.
However, banks may face challenges in the upcoming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, emphasized that current provisions do not necessarily reflect recent credit quality but rather banks’ future expectations.
In the near future, banks anticipate slower economic growth, a rise in unemployment, and two interest rate cuts set for September and December. These factors could lead to increased delinquencies and defaults as the year progresses.
Citigroup’s chief financial officer Mark Mason pointed out that warning signs primarily affect lower-income consumers, who have seen their savings diminish since the pandemic.
“While we continue to see an overall resilient U.S. consumer, we also see a divergence in performance and behavior across FICO and income bands,” Mason stated. He noted that only the highest income quartile has more savings than at the beginning of 2019, with higher FICO score customers leading in spending growth and maintaining high payment rates. In contrast, lower FICO band customers are experiencing sharper declines in payment rates and are borrowing more as they are significantly impacted by inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% while awaiting stability in inflation metrics toward the central bank’s 2% target before proceeding with anticipated rate cuts.
At present, despite banks preparing for more defaults later this year, defaults are not escalating at a level indicative of a consumer crisis, according to Mulberry. He is monitoring the distinctions between homeowners and renters during the pandemic.
“Yes, rates have increased significantly since then, but homeowners locked in historically low fixed rates, and as such, they’re still not experiencing substantial pain,” Mulberry explained. “Renters, however, missed that opportunity.”
Nationwide, rents rose by over 30% between 2019 and 2023, while grocery costs increased by 25% in the same timeframe. Renters who could not secure low rates and are facing escalating rental prices that outpace wage growth are experiencing more strain on their budgets.
Overall, the latest earnings reports indicate that there were no alarming changes in asset quality. In fact, robust revenues, profits, and stable net interest income are encouraging signs for the health of the banking sector.
“There’s some strength in the banking sector that may not have been entirely unexpected, and it’s reassuring to see that the financial system remains strong and sound at this time,” Mulberry concluded. “However, we must monitor the situation closely, as prolonged high-interest rates could increase stress within the sector.”