With interest rates at their highest levels in over 20 years and inflation impacting consumers, major banks are gearing up 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 are the funds financial institutions allocate to guard against potential losses from credit risks, including bad debts and various types of loans, such as commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion in provisions for credit losses in 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 reserve from the previous quarter—and Wells Fargo made provisions of $1.24 billion.
The increase in provisions indicates that banks are preparing for a more challenging environment, with both secured and unsecured loans posing potential risks. A recent report by the New York Federal Reserve found that Americans owe a collective $17.7 trillion in various consumer loans, including student loans and mortgages.
Furthermore, credit card issuances and delinquency rates are on the rise as individuals deplete their pandemic-era savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances exceeded the trillion-dollar mark, as reported by TransUnion. The commercial real estate sector also remains in a vulnerable state.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted, “We’re still coming out of this COVID era, particularly concerning banking and consumer health, largely due to the stimulus provided to consumers.”
Challenges for banks are expected to unfold in the coming months.
Mark Narron, a senior director at Fitch Ratings, explained, “The provisions you see in any quarter do not necessarily reflect credit quality over the past three months; they indicate banks’ expectations for the future.”
He added that the financial landscape has shifted from a system where rising loan defaults caused provisions to increase to one where macroeconomic conditions drive provisioning decisions.
In the short term, banks are anticipating slower economic growth, a higher unemployment rate, and two interest rate cuts later this year, which could lead to more delinquencies and defaults by year’s end.
Citigroup’s chief financial officer, Mark Mason, pointed out that concerns are primarily emerging among lower-income consumers, who have seen their savings decline since the pandemic began. He stated, “While the U.S. consumer remains generally resilient, we are observing differing performance across income levels and credit scores.”
Mason noted that only the top income quartile has retained more savings than they had in early 2019, with higher-credit-score customers leading in spending growth and maintaining payment rates. Conversely, customers with lower credit scores are experiencing significant drops in payment rates and are borrowing more, feeling the pressure from high inflation and interest rates.
The Federal Reserve is maintaining interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation towards its 2% target before proceeding with expected rate cuts.
Despite banks bracing for potential defaults later this year, Mulberry observed that current default rates do not indicate a consumer crisis. He emphasized the importance of differentiating between homeowners during the pandemic and renters.
He explained that although interest rates have risen, homeowners secured low fixed-rate mortgages and are not experiencing severe financial distress, unlike renters who missed out on those opportunities.
With rents rising over 30% nationwide from 2019 to 2023 and grocery prices up 25% during the same period, renters face more strain as their expenses surpass wage growth.
Overall, Narron noted that there were no new concerns regarding asset quality this quarter. Strong revenues, profits, and robust net interest income signal a healthy banking sector for now.
Mulberry commented, “The strength in the banking sector is reassuring, but we are closely monitoring the situation, as prolonged high interest rates could lead to increased stress.”