As interest rates remain at their highest levels in over 20 years and inflation continues to pressure consumers, major banks are bracing for increased risks stemming from their lending practices.
In the second quarter, leading banks including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo reported an increase in their provisions for credit losses compared to the previous quarter. These provisions are funds set aside to manage potential losses from credit risks, such as bad debts and delinquencies, particularly in commercial real estate (CRE) 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, more than triple its reserve build from the prior quarter, and Wells Fargo reported $1.24 billion in provisions.
These accumulated provisions indicate that banks are preparing for a potentially riskier economic landscape, where both secured and unsecured loans could lead to larger losses. A recent analysis by the New York Federal Reserve revealed that American households are burdened with a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also increasing as consumers exhaust pandemic-era savings and increasingly depend on credit. The total credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where the total exceeded the trillion-dollar threshold, according to TransUnion. Meanwhile, the CRE sector remains particularly vulnerable.
“We’re still transitioning out of the COVID era, particularly in banking and consumer health, largely due to the stimulus provided to consumers,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any potential issues for banks may surface in the months ahead. Mark Narron, a senior director at Fitch Ratings, noted that the provisions reported in any quarter typically reflect banks’ expectations for future credit quality rather than past performance.
“It’s interesting to observe that we’ve shifted from a system where rising loan defaults led to increased provisions, to one where macroeconomic forecasts drive provisioning decisions,” Narron explained.
Short-term forecasts from banks indicate a slowdown in economic growth and a rise in unemployment, along with anticipated interest rate cuts later this year. This scenario could lead to heightened delinquencies and defaults as the year ends.
Citi CFO Mark Mason pointed out that emerging issues seem to be particularly affecting lower-income consumers, whose savings have diminished since the pandemic began.
“While the overall U.S. consumer appears resilient, we are seeing a divergence in performance based on income levels and credit scores,” Mason stated in a recent analyst call. He revealed that only the highest-income quartile has managed to increase their savings since early 2019, with only high-FICO score customers driving growth in spending and maintaining strong payment rates. In contrast, customers with lower credit scores are experiencing sharper declines in payment rates while increasing their borrowing.
The Federal Reserve has maintained interest rates at a peak of 5.25-5.5%, awaiting stabilization in inflation rates towards the central bank’s target of 2% before considering cuts.
Despite preparations for an uptick in defaults, Mulberry indicated that current default rates do not suggest an impending consumer crisis. He is particularly attentive to differences between households that owned homes during the pandemic and those who rented.
“Yes, rates have surged since then, but homeowners locked in very low fixed rates, so they aren’t feeling the pinch as much,” Mulberry noted. “Renters missed that opportunity.”
With rental prices soaring over 30% nationwide since 2019 and grocery costs climbing 25% during the same period, renters who couldn’t secure low rates are struggling to keep up with rent hikes that have outpaced wage growth.
For the time being, the key takeaway from the latest earnings reports is that there were no new concerns regarding asset quality. Strong revenues, profits, and solid net interest income are positive signs for the banking sector’s health.
“There is some strength in the banking sector, which may not have been anticipated, but it’s reassuring to see that the foundations of the financial system remain robust,” Mulberry stated. “However, we are closely monitoring the situation, as prolonged high interest rates can lead to greater stress.”