As interest rates reach levels not seen in over 20 years 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 all increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside by financial institutions to cover potential losses from credit risks, including overdue or bad debts, as well as loans such as those for commercial real estate.
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, more than tripling its reserves from the previous quarter, and Wells Fargo had provisions amounting to $1.24 billion.
The increase in reserves indicates that banks are preparing for a more challenging economic environment, where both secured and unsecured loans could lead to greater losses. A recent report from the New York Fed highlighted that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, the issuance of credit cards and the rates of delinquency are rising as consumers deplete their savings accrued during the pandemic and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter that combined cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. Commercial real estate also remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted the ongoing recovery from the COVID-19 pandemic, particularly regarding consumer health was significantly supported by stimulus measures.
However, the challenges ahead could affect banks in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that quarterly provisions do not necessarily reflect recent credit quality but rather banks’ expectations for the future.
Narron emphasized that the transition from a system where rising loan defaults drove provisions to one where macroeconomic forecasts dictate provisioning is noteworthy. Currently, banks anticipate slower economic growth, a higher unemployment rate, and potential interest rate cuts later this year, which could lead to more delinquencies and defaults by year-end.
Citi’s chief financial officer, Mark Mason, highlighted that the emerging concerns are particularly pronounced among lower-income consumers, who have seen their savings decline since the pandemic. He noted that while the overall U.S. consumer remains resilient, there is a noticeable divide in performance across different income levels and credit scores.
Mason pointed out that only the highest income quartile has maintained more savings than before 2019, and customers with scores over 740 are driving spending growth and high payment rates. In contrast, those with lower credit scores are experiencing noticeable drops in payment rates and are increasingly borrowing due to the strain from high inflation and interest rates.
The Federal Reserve has kept interest rates at a 23-year high of 5.25% to 5.5%, waiting for inflation to stabilize towards its 2% target before considering the anticipated rate cuts.
Although banks are preparing for an increase in defaults later this year, current trends do not indicate an immediate consumer crisis, according to Mulberry. He is particularly attentive to the differences between homeowners and renters since the pandemic. Homeowners, who locked in low fixed rates during that time, are less affected by rising rates, unlike renters who have seen rents increase significantly.
With rent prices soaring over 30% nationwide from 2019 to 2023 and grocery costs also rising by 25%, renters are facing greater financial stress, especially given that rental increases have outpaced wage growth.
Despite these challenges, the latest earnings reports show no new concerns regarding asset quality. Strong revenues, profits, and net interest income are encouraging signs for a banking sector that remains resilient.
Mulberry concluded that while there is underlying strength in the banking sector, ongoing high interest rates could create more pressure in the future.