As interest rates reach levels not seen in over 20 years and inflation continues to pressure consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, leading financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo have all increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds set aside to mitigate potential losses from credit risk, which includes bad debt and other loans like 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 reached $21.8 billion, marking over a threefold increase from the prior quarter, and Wells Fargo reported provisions of $1.24 billion.
These provisions indicate that banks are preparing for a more challenging financial landscape, where both secured and unsecured loans may result in greater losses. According to a recent analysis by the New York Fed, American households currently hold a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards is on the rise, alongside soaring delinquency rates as individuals deplete their pandemic-era savings and increasingly rely on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, a record high for the second consecutive quarter, as reported by TransUnion. The commercial real estate market continues to face significant uncertainty as well.
Brian Mulberry, a portfolio manager at Zacks Investment Management, commented, “We’re still emerging from the COVID era, particularly regarding banking and consumer health, largely due to the stimulus provided to consumers.”
However, challenges for banks are anticipated in the months to come. “The provisions reported in any given quarter do not necessarily reflect recent credit quality but rather what banks foresee happening in the future,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He noted a shift in the banking system, where macroeconomic forecasts now drive loan provisioning rather than solely increases in defaulting loans.
Looking ahead, banks forecast slowing economic growth, rising unemployment, and potential interest rate cuts later this year in September and December, which could lead to more delinquencies and defaults as the year closes.
Mark Mason, Citi’s chief financial officer, highlighted that warning signs seem to be affecting lower-income consumers, who have seen their savings diminish since the pandemic. “While the overall U.S. consumer appears resilient, there are noticeable variations in performance and behavior among different income groups,” he stated.
Mason pointed out that only the highest income quartile has increased its savings since early 2019. Most spending growth and high payment rates are coming from consumers with FICO scores over 740. In contrast, those with lower FICO scores are experiencing significant drops in payment rates and are borrowing more as they face heightened inflation and interest rates.
The Federal Reserve is maintaining interest rates between 5.25% and 5.5%, a 23-year high, as it awaits stabilization in inflation closer to its 2% target before considering anticipated rate cuts.
Despite preparing for increased defaults, Mulberry noted that current default rates do not indicate an impending consumer crisis. He is observing differences between those who owned homes during the pandemic and those who rented. “Homeowners locked in low fixed rates despite rising overall rates and thus are not feeling the squeeze as severely,” he explained. “Conversely, renters have faced a steep increase in rents and limited wage growth, leading to tighter monthly budgets.”
For now, the latest earnings reports indicate stability, with strong revenues and net interest income suggesting a healthy banking sector. Narron remarked, “There was no significant change this quarter regarding asset quality. The resilience within the banking sector remains, and while the financial system is still robust, prolonged high interest rates may lead to increased stress.”