As interest rates remain at their highest levels in over 20 years and inflation continues to affect consumers, major banks are bracing for heightened risks associated with their lending activities.
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 serve as a financial buffer for potential losses related to credit risks, including bad debt and loans related to 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 credit loss allowance reached $21.8 billion, significantly more than in the prior quarter, and Wells Fargo’s provisions totaled $1.24 billion.
These increased provisions indicate that banks are preparing for a challenging lending environment, where both secured and unsecured loans could lead to larger losses. A recent analysis by the New York Fed reported that American households collectively owe $17.7 trillion on various forms of debt, including consumer loans, student loans, and mortgages.
Credit card issuance is on the rise, along with delinquency rates, as many individuals exhaust their savings from the pandemic and increasingly rely on credit. Credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. Additionally, the commercial real estate sector remains vulnerable.
Experts suggest that the current situation is a consequence of post-pandemic conditions, primarily fueled by prior consumer stimulus measures. “We’re still coming out of this COVID era, and mainly when it comes to banking and the health of the consumer, it was all of the stimulus that was deployed to the consumer,” noted Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Challenges for banks are expected to increase in the coming months. Mark Narron, a senior director at Fitch Ratings, clarified that credit provisions in any quarter reflect banks’ forecasts for future credit quality rather than past performance.
“It’s a little interesting, because we’ve moved from a system where, when loans started to go bad, provisions would go up, to one where macroeconomic forecasts drive provisioning,” Narron explained.
In the short term, banks anticipate slower economic growth, higher unemployment, and potential interest rate cuts later this year. This forecast suggests an uptick in delinquencies and defaults as the year progresses.
Citi’s CFO Mark Mason highlighted concerns among lower-income consumers, who have seen their savings diminish since the pandemic. He remarked that, while the overall U.S. consumer remains resilient, there is a notable performance gap based on income and credit scores.
“The highest income quartile has more savings than they did at the beginning of 2019, while lower FICO band customers are experiencing declines in payment rates and increased borrowing as they face higher inflation and interest rates,” Mason stated.
The Federal Reserve has maintained interest rates at a two-decade high of 5.25-5.5%, awaiting stabilization in inflation toward its 2% target before implementing anticipated rate cuts.
Despite banks preparing for future defaults, current default rates do not signal an impending consumer crisis, according to Mulberry. He emphasized that homeowners who secured low fixed rates during the pandemic are less affected compared to renters, who are struggling with rising rent costs.
Rent prices have surged more than 30% nationally from 2019 to 2023, alongside a 25% rise in grocery costs, putting significant financial pressure on renters who could not lock in low rates.
Overall, the latest earnings reports indicate no significant changes in asset quality. Strong revenues and resilient net interest income suggest that the banking sector remains healthy. “There’s some strength in the banking sector that I don’t know was totally unexpected, but it’s a relief to see that the financial system is still strong and sound at this point in time,” Mulberry stated, while cautioning that prolonged high-interest rates could lead to more stress in the future.