As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks associated with lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all significantly increased their provisions for credit losses compared to the previous quarter. These provisions represent funds set aside by banks to cover potential losses from bad debts and credit risks, particularly in areas such as commercial real estate loans.
Specifically, JPMorgan allocated $3.05 billion for credit losses, 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, marking a more than threefold increase from the prior quarter. Wells Fargo’s provisions totaled $1.24 billion.
This buildup in reserves indicates that banks are preparing for a potentially riskier environment, where both secured and unsecured loans might lead to larger losses for some of the country’s largest institutions. A recent analysis from the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as consumers exhaust their pandemic-era savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances exceeded the trillion-dollar threshold. The commercial real estate sector also remains in a challenging position.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking sector and consumer health are still grappling with the aftermath of the COVID era, primarily driven by the stimulus measures that were provided.
Challenges for banks are expected to become more pronounced in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that provisions reflect banks’ expectations about future credit quality rather than just recent trends.
Currently, banks are anticipating a slowdown in economic growth, a rise in unemployment, and potential interest rate cuts later this year, which could lead to an increase in delinquencies and defaults.
Citi’s chief financial officer Mark Mason highlighted that there are warning signs concentrated among lower-income consumers, who have seen their savings diminished since the pandemic. He mentioned that, while the overall U.S. consumer appears resilient, there is a notable divergence in performance and behavior across different income levels.
Mason indicated that only the highest income quartile has maintained more savings than they had at the beginning of 2019, with customers having FICO scores above 740 driving consumer spending and showing strong payment rates. In contrast, lower FICO score customers are experiencing more significant declines in payment rates and are accumulating more debt due to the pressures of high inflation and interest rates.
The Federal Reserve has sustained interest rates at a 23-year high of 5.25-5.5% as it seeks stabilization in inflation measures towards its 2% target before considering rate cuts.
Despite banks preparing for possible defaults in the latter half of the year, current default rates have not yet reached levels indicative of a widespread consumer crisis. Mulberry notes the distinction between the experiences of homeowners and renters during the pandemic, with homeowners having locked in low fixed rates and not feeling the immediate pressure, while renters face the brunt of increased costs.
As rents have surged over 30% nationwide and grocery prices have climbed 25% between 2019 and 2023, renters without low-rate mortgages are experiencing significant strain on their finances.
For now, recent earnings reports indicate that there are no significant new issues regarding asset quality. Strong revenues, profits, and consistent net interest income suggest that the banking sector remains robust and healthy overall.
Mulberry maintains that the banking sector currently shows strength, which is reassuring given the persistent high interest rates, although increased pressure may arise the longer these rates remain elevated.