Amidst interest rates hitting more than a two-decade high and inflation affecting consumers, major banks are bracing for increased risks linked to 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 represent funds set aside by financial institutions to cover potential losses stemming from credit risks, including bad debts and lending, particularly in commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, more than triple its credit reserve increase from the prior quarter. Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a more precarious lending environment where both secured and unsecured loans could lead to greater losses. A recent analysis by the New York Fed found that American households owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards and delinquency rates are also climbing as pandemic-related savings diminish, prompting consumers to rely more heavily on credit. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances surpassed one trillion dollars. Additionally, the commercial real estate sector remains uncertain.
“We’re still emerging from the COVID era, and a lot of the consumer health has been bolstered by the stimulus provided during the pandemic,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, potential issues for banks may arise in the months ahead. “The provisions seen in any quarter do not necessarily reflect credit quality over the last three months; rather, they indicate what banks anticipate will happen in the future,” noted Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
The banks are forecasting slow economic growth, higher unemployment rates, and interest rate reductions later this year in September and December, which could lead to increased delinquencies and defaults by year-end.
Citi’s chief financial officer Mark Mason pointed out that these warning signs are predominantly among lower-income consumers who have seen their savings diminish significantly since the pandemic began.
“While the overall U.S. consumer appears resilient, we observe distinct performance disparities across FICO scores and income levels,” Mason stated in a recent analyst call. He added that only the highest income quartile has maintained more savings than they had in early 2019, with higher FICO score customers driving spending growth while those in lower FICO bands are facing declining payment rates and escalating borrowing due to the pressures of inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high between 5.25% and 5.5%, waiting for inflation to stabilize towards its 2% target before executing anticipated rate cuts.
Despite banks gearing up for broader defaults in the latter half of the year, current default rates do not signal a consumer crisis, according to Mulberry. He is closely monitoring the situation between homeowners and renters who experienced the pandemic differently.
“Yes, rates have significantly increased since then, but homeowners locked in low fixed rates on their debts, so they haven’t felt the impact as severely,” Mulberry explained. “Conversely, renters have missed out on that opportunity during that period.”
With rents rising over 30% nationwide from 2019 to 2023 and grocery prices increasing by 25% during the same timeframe, renters facing high rental costs exceeding wage growth are experiencing the most financial strain, according to Mulberry.
For the time being, the latest round of earnings indicates that “there was nothing new this quarter in terms of asset quality,” according to Narron. He pointed out that strong revenues, profits, and resilient net interest income reflect a still-vibrant banking sector.
“There’s a certain strength within the banking sector that’s somewhat reassuring, as it indicates the financial system’s structures remain robust,” Mulberry asserted. “However, it’s important to remain observant; the longer interest rates remain this elevated, the more stress will emerge.”