With interest rates at their highest in more than two decades and inflation continuing to pressure consumers, major banks are gearing up to face increased risks from 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 risk, including delinquent or bad debt and loans like commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citi’s allowance for credit losses totaled $21.8 billion at the quarter’s end, more than tripling its credit reserve from the previous quarter; and Wells Fargo had provisions of $1.24 billion.
These reserves indicate that banks are preparing for a riskier environment where both secured and unsecured loans could result in larger losses for some of the nation’s biggest banks. A recent analysis by the New York Fed revealed that Americans collectively owe $17.7 trillion on consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise as people’s pandemic-era savings deplete and reliance on credit increases. Credit card balances totaled $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where cardholder balances exceeded the trillion-dollar mark, according to TransUnion. Additionally, the CRE sector remains unstable.
“We’re still emerging from the COVID era, particularly in regards to banking and consumer health, largely due to the stimulus deployed to consumers,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any banking issues are expected to unfold in the coming months.
“The provisions you see in any given quarter don’t necessarily reflect credit quality from the past three months; they reflect what banks anticipate in the future,” said Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
Narron noted that banks are currently forecasting slower economic growth, a higher unemployment rate, and two interest rate cuts later this year in September and December. This could lead to more delinquencies and defaults by the year’s end.
Citi’s Chief Financial Officer, Mark Mason, observed that these risks seem concentrated among lower-income consumers, whose savings have diminished since the pandemic.
“While we continue to see an overall resilient U.S. consumer, performance and behavior vary significantly across FICO scores and income levels,” Mason said in a call with analysts earlier this month.
“Only the highest income quartile among our consumer clients has more savings than at the start of 2019. It is the over-740 FICO score customers driving spending growth and maintaining high payment rates,” he said. “Lower FICO band customers are experiencing sharper declines in payment rates and borrowing more as they are more severely impacted by high inflation and interest rates.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, waiting for inflation measures to stabilize toward its 2% target before implementing the anticipated rate cuts.
Despite banks preparing for higher defaults in the year’s second half, defaults have not yet risen to levels indicating a consumer crisis, according to Mulberry. He is particularly monitoring the difference between people who owned homes during the pandemic versus renters.
“Homeowners locked in very low fixed rates during that period, so they’re not really feeling the pain. Renters, however, didn’t get that opportunity,” Mulberry said.
With nationwide rents up more than 30% from 2019 to 2023 and grocery costs rising 25% in the same period, renters who didn’t lock in low rates and are struggling with rising rental prices that outpace wage growth are feeling the most financial stress, according to Mulberry.
The main takeaway from the latest round of earnings is that “there was nothing new this quarter in terms of asset quality,” Narron said. Strong revenues, profits, and resilient net interest income are positive indicators of a still-healthy banking sector.
“There’s strength in the banking sector that might have been somewhat expected but is still reassuring to see. The structures of the financial system remain strong and sound at this point,” Mulberry said. “However, we are closely watching, as prolonged high-interest rates continue to cause stress.”