As interest rates reach their highest levels in over two decades and inflation continues to burden consumers, major banks are bracing for increased 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 represent funds that banks set aside to cover potential losses resulting from credit risks, including delinquent accounts and bad debts, particularly in the realm of commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses during this period, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, more than tripling its reserves from the previous quarter. Wells Fargo, on the other hand, reported provisions of $1.24 billion.
The accumulation of these reserves indicates that banks are preparing for a more challenging environment, where both secured and unsecured loans may lead to greater losses. A recent report from the New York Federal Reserve revealed that Americans collectively owe $17.7 trillion across various forms of debt, including consumer loans, student loans, and mortgages.
Moreover, credit card issuance and delinquency rates are on the rise as consumers exhaust their pandemic-era savings and increasingly rely on credit. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where the total exceeded the trillion-dollar threshold. Additionally, commercial real estate continues to be in a vulnerable position.
“We’re still emerging from the COVID era, particularly in banking and consumer health, which benefited from extensive stimulus measures,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, potential challenges for banks are anticipated in the near future. According to Mark Narron, a senior director at Fitch Ratings, the provisions reported by banks at the end of any quarter do not solely reflect the credit quality observed over the prior three months; rather, they indicate banks’ expectations for the future.
Narron also noted a shift in the banking sector’s approach to provisioning, where macroeconomic forecasts have become a significant driver, moving away from the previous practice of raising provisions only in response to rising loan defaults.
In the near term, banks project slower economic growth, a higher unemployment rate, and possible interest rate cuts in September and December, which may lead to increased delinquencies and defaults as the year comes to a close.
Citi’s CFO Mark Mason pointed out worrying trends primarily among lower-income consumers who have seen their savings diminish since the pandemic’s onset. He noted that while the overall U.S. consumer appears resilient, performance and behavior vary significantly across different income brackets.
“Among our consumer clients, only those in the highest income quartile have maintained higher savings compared to early 2019,” Mason explained. “Those with a credit score over 740 are driving spending growth and maintaining high payment rates, whereas individuals with lower credit scores are experiencing sharp declines in payment rates and borrowing more, influenced heavily by high inflation and interest rates.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation metrics toward the central bank’s 2% goal before implementing anticipated rate cuts.
Despite banks anticipating increased defaults later in the year, current default rates do not yet signify a consumer crisis, according to Mulberry. He is closely observing the distinction between homeowners and renters during the pandemic.
“While rates have risen significantly, homeowners locked in low fixed rates on their debts and are largely not feeling the pain. Renters, however, who lacked that advantage are facing greater financial stress,” Mulberry stated. With national rents having risen by over 30% between 2019 and 2023 and grocery costs up 25% during the same timeframe, many renters are struggling to keep pace with rising costs that have outstripped wage growth.
Overall, the latest earnings report indicates a lack of new issues regarding asset quality. Strong revenues, profits, and resilient net interest income signal a robust banking sector.
“There’s strength in the banking sector, confirming that the financial system remains solid at this time,” Mulberry concluded. However, he cautioned that as interest rates stay elevated, ongoing stress may continue to mount.