As interest rates reach their highest levels in over 20 years and inflation continues to exert pressure on consumers, major banks are bracing for increased risks in their lending strategies.
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 by financial institutions to cover potential losses from credit risks, which include delinquent loans and issues with commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit loss provisions, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, a more than threefold increase from the prior quarter. Wells Fargo set aside $1.24 billion for the same purposes.
These increased reserves indicate that banks are preparing for a more volatile environment, where both secured and unsecured loans might lead to greater losses. According to an analysis by the New York Fed, Americans collectively owe approximately $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, both credit card issuance and delinquency rates are climbing as pandemic-era savings dwindle, prompting consumers to rely more heavily on credit. Total credit card balances soared to $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that the total exceeded the trillion-dollar threshold. The commercial real estate sector also remains vulnerable.
“We’re still recovering from the COVID era, especially regarding banking and consumer health, which largely relied on the stimulus measures provided to consumers,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Challenges for banks are anticipated in the months ahead. Mark Narron, a senior director at Fitch Ratings, explained that provisions reported in a given quarter often do not reflect credit quality from that period but rather what banks predict will happen in the future.
“It’s interesting because we have transitioned from a historical system where bad loans drove provisions upward, to one where macroeconomic forecasts heavily influence provisioning,” he noted.
Currently, banks foresee a slowdown in economic growth, a rise in unemployment, and potential interest rate cuts occurring in September and December. These factors could contribute to increasing delinquency and default rates as the year concludes.
Citi’s chief financial officer, Mark Mason, highlighted concerns that are particularly acute among lower-income consumers, who have experienced a significant decline in savings since the pandemic.
“While the overall U.S. consumer remains resilient, there is a noticeable disparity in performance and behavior across different income and credit score segments,” Mason stated in a recent analyst call. He noted that only the highest income quartile has more savings than at the beginning of 2019. Customers with FICO scores above 740 are driving spending growth and maintaining high payment rates, whereas those with lower scores are facing declining payment rates and are increasingly reliant on credit amid high inflation and interest rates.
The Federal Reserve has maintained a 23-year high interest rate range of 5.25-5.5% as it waits for inflation indicators to stabilize closer to its 2% target before implementing widely anticipated rate cuts.
Despite banks preparing for potential increases in defaults later this year, current trends do not indicate an imminent consumer crisis, according to Mulberry. He is monitoring the contrast between pandemic homeowners and renters, noting that while interest rates have surged, homeowners typically secured low fixed-rate mortgages and are less affected.
On the other hand, renters, who generally did not benefit from fixed-rate opportunities, are experiencing significant financial strain as rents have risen over 30% nationally from 2019 to 2023, along with grocery costs increasing by 25%.
For now, analysts conclude that the recent earnings reports indicate stability in asset quality. “There’s nothing particularly new this quarter concerning asset quality,” Narron commented. Robust revenues, profits, and strong net interest income suggest that the banking sector remains healthy.
Mulberry added, “There’s strength in the banking sector that may have been anticipated, providing a sense of relief that the financial system remains robust and sound. However, the extended duration of high interest rates continues to exert stress on the system.”