With interest rates at their highest in over 20 years and inflation still impacting consumers, major banks are preparing for increased risks related to 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 reserves set aside by financial institutions to cover potential losses from credit risks, including delinquent debts and commercial real estate loans.
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 at the end of the quarter, more than tripling its reserve build from the previous quarter. Wells Fargo recorded provisions of $1.24 billion.
These increased reserves signify that banks are preparing for a challenging lending environment, where both secured and unsecured loans may lead to greater losses. A recent analysis by the New York Federal Reserve revealed that Americans owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
As pandemic-era savings diminish, credit card issuance and delinquency rates are also increasing. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. Commercial real estate continues to face uncertainty as well.
“We are still emerging from the COVID period, particularly regarding banking and consumer health, much of which was supported by stimulus funds,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Challenges for banks are anticipated in the coming months. “The provisions you see in any quarter do not necessarily mirror credit quality from the past three months; they reflect what banks predict for the future,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He noted a shift in how provisions are driven by macroeconomic forecasts instead of historical loan performance. In the near term, banks are forecasting slower economic growth, increased unemployment rates, and potential interest rate cuts later this year in September and December, which may lead to more delinquencies and defaults by year-end.
Mark Mason, Citi’s chief financial officer, indicated that warning signs are most prominent among lower-income consumers, who have seen their savings decrease since the pandemic. “While there is an overall resilient U.S. consumer, we are observing a divergence in performance based on income and credit scores,” Mason remarked in a recent analyst call.
He added that only the highest income quartile has more savings now compared to early 2019, and that consumers with credit scores over 740 are driving spending growth and maintaining high payment rates. In contrast, those in lower FICO bands are facing greater declines in payment rates and increasing borrowing due to the impacts of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, as it awaits signs of inflation stabilizing toward its 2% target before implementing anticipated rate cuts.
While banks are bracing for a rise in defaults later this year, currently, the rate of defaults does not indicate a consumer crisis, according to Mulberry. He is particularly focused on the divide between homeowners and renters during the pandemic.
“Though rates have risen significantly since then, homeowners locked in very low fixed rates on their debts, so they are not feeling as much financial pressure,” Mulberry explained. “In contrast, renters missed that opportunity.”
With rents surging more than 30% nationally from 2019 to 2023 and grocery prices increasing by 25% during the same period, renters who couldn’t secure low rates are experiencing substantial strain in their budgets.
Nevertheless, the latest earnings reports reveal no significant concerns regarding asset quality. Strong revenues, profits, and resilient net interest income suggest the banking sector remains healthy.
“There is some strength in the banking sector that wasn’t entirely unexpected, providing assurance that the financial system is still robust,” Mulberry added. “However, we are closely monitoring the situation, as prolonged high interest rates could create more stress.”