With interest rates reaching their highest levels in over 20 years and inflation continuing to pressure consumers, major banks are bracing for increased risks in their lending practices.
In the second quarter, major financial institutions including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their provisions for credit losses compared to the previous quarter. These provisions represent the funds banks set aside to manage potential losses from credit risks, which encompass delinquent debts and loans, including those in commercial real estate.
JPMorgan established $3.05 billion in credit loss provisions during the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses surged to $21.8 billion, more than tripling its reserves from the previous quarter, and Wells Fargo set aside $1.24 billion.
The increase in provisions indicates that banks are preparing for a riskier lending environment, where both secured and unsecured loans could lead to greater losses. Recent analysis by the New York Fed showed that U.S. households collectively owe $17.7 trillion across various forms of consumer debt, including student loans and mortgages.
The issuance of credit cards and subsequent delinquency rates are also rising as consumers deplete their pandemic-era savings and increasingly rely on credit. TransUnion reported that credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter in which total cardholder balances surpassed the trillion-dollar threshold. Furthermore, the commercial real estate sector remains in a vulnerable state.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that banks are still emerging from the impacts of the COVID-19 era and the resulting consumer stimulus.
Experts warn that any challenges for banks are likely to surface in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, emphasized that provisions reported by banks do not solely rely on recent credit quality but are influenced by their expectations of future economic conditions.
In the near future, banks anticipate slower economic growth, a rise in unemployment rates, and two interest rate cuts later this year, potentially leading to increased delinquencies and defaults as 2023 progresses.
Citigroup’s chief financial officer Mark Mason pointed out that the warning signs are predominantly among lower-income consumers, who have seen their savings decline since the pandemic.
“Although the overall U.S. consumer remains resilient, there is a noticeable divergence in performance across different income groups,” Mason explained. He added that only the highest income quartile has increased their savings since early 2019, with those in the highest FICO score brackets driving spending and maintaining robust payment rates. In contrast, those with lower FICO scores are experiencing significant drops in payment rates and are borrowing more amid the pressures of high inflation and interest rates.
The Federal Reserve maintains interest rates at a 23-year peak of 5.25-5.5%, awaiting stabilization in inflation metrics toward the desired 2% target before proceeding with anticipated rate cuts.
Despite banks gearing up for potentially higher default rates later in the year, Mulberry observed that current default rates do not yet indicate a looming consumer crisis. He noted a distinction between homeowners, who locked in low fixed rates during the pandemic, and renters, who have not benefited from similar opportunities.
Homeownership rates may shield many from financial stress, whereas renters face challenges due to surging rents, which have increased by over 30% nationally from 2019 to 2023, coupled with a 25% rise in grocery costs during the same timeframe. Renters without low fixed-rate options are facing the most financial strain in their monthly budgets.
Currently, the earnings reports indicate stability in asset quality within the banking sector. Narron remarked that despite some pressures, strong revenues, profits, and healthy net interest income reflect the continued resilience of the banking industry.
Mulberry concluded that while the banking sector shows strengths that were not entirely unexpected, ongoing high interest rates will lead to increased stress, warranting close monitoring in the months ahead.