As interest rates reach their highest levels in over 20 years and inflation continues to impact consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all reported an increase in their provisions for credit losses compared to the previous quarter. These provisions are funds that banks reserve to cover potential losses from credit risks, including delinquent debts and loans, particularly in the commercial real estate sector.
JPMorgan set aside $3.05 billion 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 at the end of the quarter, marking a significant increase from the previous quarter. Wells Fargo’s provisions totaled $1.24 billion.
These provisions indicate that banks are preparing for a riskier lending environment, where both secured and unsecured loans may lead to greater losses. The New York Fed recently reported that Americans collectively owe approximately $17.7 trillion in consumer loans, student loans, and mortgages.
Furthermore, credit card issuance has surged, along with rising delinquency rates, as consumers increasingly rely on credit due to depleting pandemic-era savings. Credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. The commercial real estate sector also remains vulnerable.
“We’re still emerging from the COVID era, and much of the banking sector’s health hinges on the stimulus provided to consumers,” explained Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, issues for banks are expected to arise in the coming months.
“The provisions reported in a given quarter do not necessarily reflect the immediate credit quality but rather what banks anticipate will happen in the future,” said Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
“This shift in approach signifies a move from a system where provision increases followed bad loans to one driven by macroeconomic forecasts,” he added.
Banks foresee a slowdown in economic growth, an uptick in unemployment, and potential interest rate cuts in September and December, which could lead to increased delinquencies and defaults by the year’s end.
Citi’s chief financial officer, Mark Mason, highlighted that warning signs are increasingly apparent among lower-income consumers, who have experienced significant declines in their savings since the pandemic.
“While the overall U.S. consumer remains resilient, we observe a divergence in performance across different income brackets and credit scores,” Mason noted in a recent analyst call.
According to him, only the wealthiest quartile of consumers has maintained more savings than in early 2019, with those having FICO scores above 740 driving spending growth and high payment rates. In contrast, lower FICO score consumers are struggling with payment rates and are borrowing more heavily due to the pressures of high inflation and interest rates.
The Federal Reserve has kept interest rates elevated at 5.25-5.5% as it awaits inflation metrics to stabilize towards its 2% target before implementing anticipated rate cuts.
Despite banks preparing for increased defaults later in the year, current default rates do not indicate a consumer crisis, according to Mulberry. He is particularly focused on the differences between homeowners and renters during the pandemic.
“Although interest rates have risen significantly, homeowners locked in low fixed rates and are not yet feeling the pinch. In contrast, renters, who missed that opportunity, face rising rental costs without the benefit of fixed-rate mortgages,” Mulberry explained.
Over the past four years, rental prices have surged by over 30%, and grocery costs have risen by 25%, leaving renters, who have not seen wage growth keep pace, with increased financial strain.
Thus far, the earnings reports from banks have shown no new concerns regarding asset quality. Strong revenues, profits, and robust net interest income are indicative of a resilient banking sector.
“There is a degree of strength in the banking sector that was not entirely unexpected, but it’s positively reassuring to see that the foundations of the financial system remain stable,” Mulberry concluded. “However, we are monitoring the situation closely, as prolonged high interest rates could lead to increased stress.”