Major banks are preparing for increased risks in their lending practices as interest rates remain at their highest levels in over two decades and inflation continues to affect consumers.
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 represent funds set aside by financial institutions to cover potential losses associated with credit risk, such as delinquent debts and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit loss provisions 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 provisions from the previous quarter, and Wells Fargo recorded provisions of $1.24 billion.
These increased provisions indicate that banks are bracing for a more challenging economic environment, marked by the potential for greater losses on both secured and unsecured loans. A recent analysis by the New York Fed revealed that American households collectively owe $17.7 trillion across various types of consumer loans, student loans, and mortgages.
Rising credit card issuance and delinquency rates are also notable as consumers rely more on credit following the depletion of their pandemic-era savings. Credit card balances surpassed $1 trillion in the first quarter of the year, marking the second consecutive quarter in which total cardholder balances exceeded this threshold, according to TransUnion. Additionally, commercial real estate remains in a precarious state.
As Brian Mulberry, a client portfolio manager at Zacks Investment Management, stated, the banking sector is still emerging from the COVID era, heavily influenced by the stimulus measures that supported consumers.
Challenges for banks are expected to arise in the upcoming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that the provisions reported in any given quarter do not necessarily reflect credit quality for that specific period; instead, they indicate banks’ expectations for future trends.
Currently, banks anticipate slower economic growth, an increase in unemployment rates, and two potential interest rate cuts later this year. This outlook could lead to more delinquencies and defaults as the year concludes.
Citi’s CFO Mark Mason highlighted that these warning signs are particularly pronounced among lower-income consumers, who have seen their savings diminish since the pandemic. While the overall U.S. consumer appears resilient, there is a noticeable disparity in performance based on credit scores and income levels.
Mason pointed out that only the highest-income quartile has more savings than they did at the start of 2019, with customers boasting FICO scores over 740 driving spending growth and maintaining high payment rates. In contrast, those with lower credit scores are experiencing significant declines in payment rates and relying more on borrowing, a situation exacerbated by high inflation and interest rates.
The Federal Reserve has sustained interest rates at a 23-year high of 5.25-5.5% while awaiting stabilization in inflation towards its 2% target before implementing anticipated rate cuts.
Despite banks preparing for wider defaults in the latter half of the year, they have not observed a concerning rise in default rates, according to Mulberry. He is particularly monitoring the divide between homeowners and renters during the pandemic. Homeowners, who locked in low fixed rates, are facing less financial strain than renters who did not have that option.
With national rent prices increasing by over 30% from 2019 to 2023 and grocery costs rising by 25% during the same timeframe, renters without locked-in low rates are under the most financial pressure.
Looking at the latest earnings reports, Narron emphasized that there were no new developments regarding asset quality this quarter. Strong revenues, profits, and resilient net interest income signal an overall healthy banking sector.
Mulberry remarked that there is still notable strength in the banking industry, indicating that the financial system remains robust, though prolonged high interest rates could lead to increased stress.