As interest rates remain at their highest levels in over 20 years and inflation continues to impact consumers, major banks are bracing for increased risks associated with their lending practices.
During 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 serve as a financial buffer to cover potential losses stemming from credit risks, including defaults on loans and delinquencies in commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance reached $21.8 billion, more than tripling its reserves from the previous quarter, and Wells Fargo provisioned $1.24 billion.
These increased reserves highlight the banks’ readiness for a more challenging lending environment, with potential losses looming from both secured and unsecured loans. An analysis by the New York Fed discovered that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising, as consumers, depleting their pandemic-era savings, turn increasingly to credit. In the first quarter, credit card balances totaled $1.02 trillion, marking the second consecutive quarter in which overall cardholder balances surpassed this threshold, according to TransUnion. Additionally, the CRE sector is navigating a precarious landscape.
“We’re still recovering from the COVID era, and when it comes to banking and consumer health, much of it was driven by government stimulus,” commented Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Experts warn that banking challenges may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, stated that current provisions do not solely reflect recent credit quality but rather banks’ expectations for future conditions. This shift indicates that macroeconomic forecasts now heavily influence provisioning decisions.
In the near future, banks are anticipating slowing economic growth and a rise in unemployment, predicting two interest rate cuts later this year in September and December. This could lead to increased delinquencies and defaults as the year draws to a close.
Citigroup’s chief financial officer, Mark Mason, pointed out that the risks are notably pronounced among lower-income consumers, who have seen their financial cushions diminish since the pandemic began. “While the overall U.S. consumer remains resilient, we observe a performance divergence across income and credit score brackets,” he noted.
Only the highest-income consumers have retained more savings than they had in early 2019, with those boasting FICO scores over 740 driving spending growth. Conversely, lower FICO score borrowers are facing steep declines in payment rates and are increasingly reliant on credit, adversely affected by rising inflation and interest rates.
The Federal Reserve continues to maintain interest rates between 5.25% and 5.5%, waiting for inflation to stabilize around its 2% target before implementing expected rate cuts.
Despite banks preparing for increased defaults later in the year, Mulberry believes that current default rates do not indicate a consumer crisis. He highlights a contrast between homeowners, who locked in low fixed-rate mortgages during the pandemic, and renters, who are now experiencing financial strain as rental costs have surged.
Between 2019 and 2023, rental prices skyrocketed by over 30%, while grocery prices have increased by 25%. This economic pressure is squeezing the budgets of renters who missed the opportunity to secure lower rates.
Overall, the latest earnings reports reveal a lack of alarming news regarding asset quality. Strong revenues and profits, along with resilient net interest income, are positive signs for the banking sector. “The banking system remains robust, but the longer interest rates stay high, the more strain it could cause,” Mulberry added.