As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for potential risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions are reserves set aside to manage potential losses from credit risks, including delinquent debts and commercial real estate (CRE) loans.
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 by the end of the quarter, a significant increase from the previous quarter. Wells Fargo reported provisions of $1.24 billion.
This increase in reserves indicates that banks are preparing for a potentially riskier lending environment, where both secured and unsecured loans might lead to greater losses. A recent report by the New York Fed highlighted that Americans collectively owe $17.7 trillion in various consumer debts, including loans and mortgages.
Credit card issuance and delinquency rates are also climbing as individuals deplete their pandemic-era savings and increasingly turn to credit. In the first quarter, total credit card balances exceeded $1 trillion for the second consecutive quarter, according to TransUnion. The situation for commercial real estate remains precarious as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, stated, “We’re still coming out of this COVID era, and primarily due to the stimulus that was provided to consumers.”
Future issues for banks are anticipated in the upcoming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported in any quarter do not solely reflect recent credit quality but rather what banks predict will happen in the future.
He noted a shift in how banks operate, moving away from a system in which increases in troubled loans directly led to greater provisions, to one where macroeconomic forecasts drive their provisioning decisions.
Short-term projections from banks suggest slowing economic growth, a higher unemployment rate, and anticipated interest rate cuts in September and December, potentially leading to an increase in delinquencies and defaults as the year ends.
Citi’s chief financial officer, Mark Mason, indicated that the risks are particularly concentrated among lower-income consumers, whose savings have diminished since the pandemic. He observed that while the overall U.S. consumer remains resilient, disparities exist based on income and credit scores.
Mason noted that only the highest income quartile has maintained more savings than they had in 2019, with those in the upper credit score brackets driving spending growth and sustaining high payment rates. Conversely, individuals with lower credit scores are experiencing a decline in payment rates and are increasingly borrowing as they feel the impacts of high inflation and interest rates more acutely.
The Federal Reserve has held interest rates at a 23-year peak of 5.25-5.5%, awaiting signs of stabilization in inflation toward its 2% target before implementing planned rate cuts.
Currently, while banks are preparing for more defaults, the rate of defaults is not escalating to a level indicative of a consumer crisis, according to Mulberry. He pointed out a distinct divide between those who owned homes during the pandemic and those who rented.
He explained, “Yes, rates have gone up significantly since then, but [homeowners] locked in very low fixed rates on their debts, so they’re still not feeling the pressure as much.” In contrast, renters have faced rental prices that have surged over 30% nationwide since 2019, with grocery costs rising by 25%, creating significant financial strain for those without the advantage of fixed-rate payments.
Overall, the latest earnings reports reveal that there were no surprising developments regarding asset quality. Strong revenue, profits, and robust net interest income indicate a healthy banking sector currently.
Mulberry concluded, “There’s some strength in the banking sector that I don’t think was entirely unexpected, but it’s certainly reassuring to see that the financial system remains strong. However, we are closely monitoring the situation, as prolonged high interest rates could increase stress on the system.”