With interest rates at their highest in over 20 years and inflation significantly impacting 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 increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside by banks to account for potential losses from credit risks, including overdue debts and problematic loans, such as those in commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s total reached $21.8 billion, more than tripling its reserves from the previous quarter; and Wells Fargo added $1.24 billion in provisions.
The buildup in reserves indicates that banks are preparing for a potentially riskier environment, where both secured and unsecured loans could lead to more significant losses. A recent report from the New York Fed revealed that Americans collectively owe $17.7 trillion in various debt types, including consumer and student loans as well as mortgages.
Credit card issuance and delinquency rates are also on the rise as consumers deplete their pandemic-era savings and increasingly rely on credit. Total credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total balances surpassed this milestone, as reported by TransUnion. Additionally, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, stated, “We’re still emerging from the COVID era, and the stimulus deployed to consumers has played a significant role in banking and consumer health.”
However, any challenges for banks are anticipated in the upcoming months.
“The provisions reported for any quarter do not directly reflect the credit quality observed in the last three months but rather represent banks’ expectations for future trends,” commented Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He added that there has been a shift from historically reacting to bad loans to a system where macroeconomic forecasts significantly influence provisioning decisions.
In the short term, banks predict slowing economic growth, rising unemployment rates, and two interest rate cuts in September and December. This situation could lead to increased delinquencies and defaults as the year concludes.
Citi’s chief financial officer Mark Mason pointed out that these concerns are most acute among lower-income consumers, who have seen their savings diminish since the pandemic.
“While the overall U.S. consumer remains resilient, we observe disparities in performance across different income groups and credit scores,” Mason explained during a recent analyst call. He noted that only the highest income quartile has managed to maintain savings compared to early 2019, with those holding over a 740 FICO score driving spending growth and sustaining high payment rates. Conversely, lower FICO score customers are experiencing declines in payment rates while borrowing more, amid the pressures of high inflation and interest rates.
As the Federal Reserve maintains interest rates at a 23-year peak of 5.25-5.5%, it awaits signs of inflation stabilizing towards the central bank’s 2% target before implementing anticipated rate cuts.
Despite banks preparing for more defaults in the latter half of the year, Mulberry asserts that defaults have not yet surged to a level indicative of a consumer crisis. He is currently observing the differences between homeowners and renters from the pandemic era.
“While interest rates have risen considerably since then, homeowners locked in low fixed rates on their debt, so they aren’t feeling as much pressure,” Mulberry stated. “Renters, on the other hand, missed out on that benefit.”
With rental prices increasing over 30% nationally from 2019 to 2023 and grocery costs rising by 25% during the same timeframe, renters facing escalating rents without commensurate wage growth are experiencing more financial strain.
For now, the key takeaway from the latest earnings reports is that “there was nothing new this quarter in terms of asset quality,” according to Narron. He noted that strong revenues, profits, and resilient net interest income reflect a still-robust banking sector.
“There is strength in the banking sector that may not have been entirely unexpected, but it is reassuring to see that the foundations of the financial system remain solid at this moment,” Mulberry concluded. “However, the longer interest rates remain this high, the greater the potential stress on the system.”