As interest rates reach over 20-year highs and inflation weighs on consumers, major banks are bracing for potential 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 funds that banks set aside to mitigate potential losses arising from credit risks, including bad debt and loans, such as commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America reserved $1.5 billion. Citigroup’s credit loss allowance, ending the quarter at $21.8 billion, more than tripled from the previous quarter. Wells Fargo set aside $1.24 billion for similar provisions.
These increases indicate that banks are preparing for a riskier lending environment, as both secured and unsecured loans could result in greater losses. A recent analysis from the New York Fed revealed that Americans now owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are rising as consumers exhaust their pandemic-related savings and increasingly turn to credit. In the first quarter of this year, credit card balances rose to $1.02 trillion, marking the second consecutive quarter when total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. Additionally, the commercial real estate sector remains in a delicate position.
“We are still emerging from the COVID era, and the banking sector, particularly concerning consumer health, experienced significant stimulus support,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any potential problems for banks are anticipated in the coming months.
“The provisions seen each quarter do not necessarily reflect credit quality over the last three months but rather what banks expect to happen in the future,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
He added, “It’s interesting to note that we have shifted from a historical model where increasing loan defaults led to higher provisions, to one where macroeconomic forecasts largely dictate provisioning.”
In the short term, banks expect slower economic growth, a rise in unemployment, and anticipate interest rate cuts later this year in September and December. This could result in a higher incidence of delinquencies and defaults as the year concludes.
Citi’s chief financial officer Mark Mason acknowledged that warning signs are more prevalent among lower-income consumers, who have seen their savings diminish since the pandemic.
“While the overall U.S. consumer appears resilient, we observe a stark divergence in performance based on credit scores and income levels,” said Mason during a recent analyst call.
He pointed out that “only the highest income quartile has managed to increase their savings since the beginning of 2019, with over-740 FICO score customers contributing to spending growth and maintaining high payment rates. In contrast, those in lower FICO groups are experiencing sharper declines in payment rates and are borrowing more, significantly affected by elevated inflation and interest rates.”
The Federal Reserve has maintained interest rates at a two-decade high of 5.25-5.5% while awaiting stabilization in inflation metrics towards the central bank’s 2% target before enacting anticipated rate cuts.
Despite banks preparing for a potential increase in defaults later this year, current data does not indicate a rapidly rising trend that would point to a consumer crisis, according to Mulberry. He emphasized monitoring the differences between homeowners and renters from the pandemic period.
“While rates have increased considerably, homeowners secured very low fixed rates and are largely insulated from the financial strain,” Mulberry observed. “Conversely, renters did not benefit from those low rates.”
With rents rising over 30% nationally between 2019 and 2023 and grocery costs increasing by 25% in the same timeframe, renters lacking locked-in low rates are feeling the most financial pressure, Mulberry added.
For now, the most significant takeaway from the latest earnings reports is that “there was nothing new this quarter regarding asset quality,” according to Narron. He noted that strong revenues, profits, and resilient net interest income indicate a still-healthy banking sector.
“Although some strength in the banking sector may not have been entirely unexpected, it is reassuring to confirm that the financial system remains robust and sound at this time,” Mulberry remarked. “However, we are closely monitoring the situation, as prolonged high-interest rates exert increasing stress.”