With interest rates at their highest levels in over two decades and inflation impacting consumers, major banks are preparing for increased risks in 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 to cover potential losses from credit risks, including delinquent debts and lending, particularly in commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s provisions reached $21.8 billion, significantly more than the previous quarter; and Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are anticipating a more challenging lending environment, where both secured and unsecured loans could lead to greater losses. A study by the New York Fed highlighted that Americans hold a total of $17.7 trillion in consumer loans, student loans, and mortgages.
There is also a noticeable rise in credit card issuance and delinquency rates as individuals deplete their pandemic-era savings and turn to credit. Credit card balances hit $1.02 trillion in the first quarter of the year, marking the second straight quarter where totals surpassed the trillion-dollar threshold, according to TransUnion. Meanwhile, CRE remains in a delicate situation.
Brian Mulberry, a portfolio manager at Zacks Investment Management, commented on the ongoing effects of the COVID era: “It was all about the stimulus deployed to consumers.”
However, any bank-related difficulties are expected to arise in the coming months.
Mark Narron, a senior director at Fitch Ratings, explained, “Provisions noted in any quarter don’t necessarily reflect the last three months’ credit quality; rather, they indicate banks’ expectations for the future.” He stressed that a shift has occurred from a system reacting to bad loans to one where macroeconomic forecasts heavily influence provisioning.
With projections indicating a slowdown in economic growth, higher unemployment rates, and anticipated interest rate cuts later this year, banks may face increasing delinquencies and defaults as the year ends.
Citi’s CFO Mark Mason highlighted that issues seem particularly evident among lower-income consumers, who have seen their savings diminish post-pandemic. He noted that while the overall U.S. consumer appears resilient, performance varies significantly across income levels and credit scores. Only the highest income quartile has more savings than at the beginning of 2019, with those in the over-740 FICO score category driving spending growth. In contrast, customers with lower scores are experiencing declines in payment rates and are borrowing more, adversely affected by high inflation and rising interest rates.
The Federal Reserve has maintained interest rates between 5.25% and 5.5%—the highest in 23 years—awaiting indications of inflation stabilizing near its 2% target before considering rate cuts.
Despite banks bracing for potential increases in defaults, current trends do not suggest an imminent consumer crisis. Mulberry indicated that homeowners who secured low fixed mortgage rates during the pandemic are not feeling as much financial pressure compared to renters who missed that opportunity.
From 2019 to 2023, rents have surged over 30%, and grocery prices have risen by 25%. Renters, facing increased rental costs that are outpacing wage growth, are feeling the financial strain more acutely.
Overall, the recent earnings reports revealed no significant changes in asset quality. The health of the banking sector appears solid, with strong revenues and net interest income being positive signs. “There’s a resilience in the banking sector, which is reassuring, although we must remain alert as prolonged high interest rates could introduce more stress,” Mulberry concluded.