With interest rates at their highest in over 20 years and inflation impacting consumers, major banks are bracing for increased risks tied to lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all augmented their credit loss provisions compared to the previous quarter. These provisions are funds set aside by financial institutions to mitigate potential losses from credit risks, such as bad debts and delinquent loans, including those related to 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 for credit losses reached $21.8 billion at the end of the quarter, more than tripling its reserve build from the prior quarter, and Wells Fargo recorded provisions of $1.24 billion.
These increased reserves signal that banks are preparing for a tougher economic climate, where both secured and unsecured loans could lead to greater losses. According to a recent analysis by the New York Fed, American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance is rising, accompanied by higher delinquency rates, as pandemic-related savings dwindle and consumers increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where the total surpassed the trillion-dollar mark, as reported by TransUnion. Furthermore, the CRE sector is in a precarious state.
“We’re still emerging from the COVID period, and much of the current banking landscape and consumer health is a result of stimulus measures,” remarked Brian Mulberry, a portfolio manager at Zacks Investment Management.
However, potential issues for banks may surface in the upcoming months.
“The provisions reported each quarter don’t strictly indicate credit quality from the past three months; they anticipate future trends,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
“There has been a shift from a traditional model where increasing bad loans prompted higher provisions to one where macroeconomic forecasts dictate provisioning,” he added.
In the short term, banks predict slower economic growth, a rise in unemployment, and two anticipated interest rate reductions later this year, which could lead to increased delinquency and defaults as the year concludes.
Citi’s Chief Financial Officer, Mark Mason, pointed out that these warning signs are especially evident among lower-income consumers, who have experienced dwindling savings since the pandemic.
“While the overall U.S. consumer remains resilient, we see different performance and behavior patterns across income brackets,” Mason noted in a recent analyst call.
“Among our consumer clients, only those in the highest income quartile have more savings than they did pre-pandemic, and it is mostly those with a FICO score over 740 driving spending growth and maintaining effective payment rates,” he said. “In contrast, those with lower FICO scores are seeing significant drops in payment rates and are borrowing more, feeling the brunt of high inflation and interest rates.”
The Federal Reserve is holding interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation metrics towards its 2% benchmark before considering any anticipated rate cuts.
Despite banks preparing for increased defaults later this year, current data does not indicate a consumer crisis, according to Mulberry. He is particularly observing the differences between pandemic homeowners and renters.
“While interest rates have surged, homeowners secured low fixed rates on their debt and are not feeling the pain as intensely,” Mulberry stated. “Renters, however, missed out on that opportunity.”
With rent prices soaring over 30% nationwide from 2019 to 2023 and grocery costs climbing 25% in the same period, renters who did not lock in low rates are facing considerable budget pressures.
Currently, the major takeaway from the latest earnings reports is that “there are no new concerns regarding asset quality,” according to Narron. Healthy revenues, profits, and strong net interest income indicate a robust banking sector.
“There’s a resilience in the banking sector that is somewhat reassuring. The financial system’s structure remains strong and sound right now,” Mulberry commented. “However, we are closely monitoring the situation, as the longer interest rates stay elevated, the more pressure will be exerted.”