As interest rates reach their highest 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, 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 from credit risks, including bad debt and delinquent loans, particularly in commercial real estate.
JPMorgan set aside $3.05 billion in credit loss provisions for the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, more than tripling its provisions from the prior quarter, and Wells Fargo designated $1.24 billion for the same purpose.
The heightened provisions indicate that banks are preparing for a more challenging financial landscape, where the risk of defaults on both secured and unsecured loans could rise. A recent study by the New York Fed revealed that the total household debt in the U.S. has reached $17.7 trillion across various loan types, including consumer loans, student loans, and mortgages.
There has been a notable increase in credit card issuance, and delinquency rates are also climbing, as many consumers are depleting their savings accumulated during the pandemic and increasingly relying on credit. According to TransUnion, total credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that overall cardholder balances surpassed the trillion-dollar threshold. The commercial real estate sector remains particularly vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, stated that the banking sector is still recovering from the pandemic, noting that stimulus measures provided to consumers played a significant role in their financial health.
According to Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, the provisions reported by banks in any given quarter do not necessarily reflect past credit quality but are indicative of their expectations for future economic conditions. He explained that banks have shifted from responding reactively to loan defaults to proactively adjusting provisions based on broader economic forecasts.
Short-term, banks anticipate slower economic growth, higher unemployment rates, and potential interest rate cuts in September and December, suggesting that delinquencies and defaults could increase by year-end.
Mark Mason, Citigroup’s chief financial officer, highlighted that the financial struggles appear to be more pronounced among lower-income consumers, who have seen their savings decline since the pandemic.
Despite overall consumer resilience, Mason noted a divided performance across income levels and credit scores. Only consumers in the top income bracket have managed to increase their savings since early 2019, with those possessing high credit scores driving spending growth and maintaining high payment rates. Conversely, lower credit score customers are exhibiting increased borrowing and declining payment rates due to the impacts of high inflation and interest rates.
The Federal Reserve maintains interest rates at a 23-year high of 5.25-5.5%, holding off on rate cuts until inflation stabilizes towards its 2% target.
While banks are preparing for potential defaults in the latter half of the year, current trends indicate that consumer defaults have not surged to alarming levels, Mulberry observed. He is particularly monitoring the distinction between homeowners from the pandemic period and renters.
Mulberry elaborated that, even as rates have increased significantly, homeowners who secured low fixed rates on their debt are not currently feeling the financial strain. In contrast, renters, who faced over 30% increases in rent costs between 2019 and 2023, coupled with a 25% jump in grocery prices during the same period, are under considerable budgetary stress.
Nevertheless, the latest earnings reports from banks suggest that asset quality remains stable. According to Narron, strong revenues, profits, and resilient net interest income are positive signs for the banking sector’s health. Mulberry affirmed that, while the financial system appears robust, prolonged high-interest rates could lead to increased strain in the future.