As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks in 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 are the funds that banks allocate to cover potential losses from credit-related risks, including overdue debts and bad loans, particularly in commercial real estate.
JPMorgan set aside $3.05 billion for credit losses during the quarter, while Bank of America allocated $1.5 billion. Citigroup’s total for credit loss provisions climbed to $21.8 billion at the end of the quarter, significantly more than the previous quarter. Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a more volatile lending environment, where both secured and unsecured loans could lead to larger losses. A recent analysis from the New York Fed revealed that American households carry a total of $17.7 trillion in consumer loans, student loans, and mortgages.
The rise in credit card issuance and delinquency rates also reflects consumers increasingly relying on credit as their pandemic-era savings diminish. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where the total surpassed the trillion-dollar threshold, according to TransUnion. Additionally, commercial real estate remains a concerning sector.
“We’re still emerging from the COVID era, and the health of the consumer has largely depended on the stimulus that was provided,” commented Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Challenges for banks are anticipated in the coming months. “The provisions reported in any given quarter don’t necessarily indicate credit quality for the preceding three months; they reflect banks’ expectations for the future,” explained Mark Narron, senior director in Fitch Ratings’ Financial Institutions Group.
Narron added that the shift has moved from a reactive approach to provisioning, where provisions increased as loans began to fail, to a proactive stance driven by macroeconomic forecasts.
In the near future, banks expect slower economic growth, higher unemployment, and potential rate cuts in September and December, which could lead to increased delinquencies and defaults by year-end.
Citi’s chief financial officer, Mark Mason, pointed out that these concerns seem to be focused on lower-income consumers, who have seen their savings diminish since the pandemic began. “While the overall U.S. consumer remains resilient, we observe a divergence in performance based on income and credit scores,” Mason mentioned during a recent analyst call.
He noted that only the top income quartile holds more savings now compared to early 2019, with growth seen mainly in consumers with credit scores over 740. In contrast, those with lower credit scores are facing greater challenges as inflation and high-interest rates hit their finances harder.
Despite banks’ preparations for potential defaults in the latter part of the year, Mulberry pointed out that defaults are not escalating at a concerning pace indicative of a consumer crisis. Currently, he is observing trends between homeowners and renters during the pandemic.
“Though interest rates have increased significantly, homeowners secured low fixed rates on their debt, so they’re not experiencing the same financial strain,” he explained. “Conversely, renters who missed out on those opportunities are facing significant stress, given that rents have surged over 30% from 2019 to 2023, alongside a 25% increase in grocery costs.”
However, the latest earnings reports indicate that “there’s been no new development this quarter regarding asset quality,” Narron stated. In fact, the banking sector displays strong revenues, profits, and healthy net interest income, suggesting ongoing stability.
“There’s a robustness in the banking sector that was not entirely unexpected, but it is reassuring to affirm that the financial system remains strong and sound,” Mulberry remarked. “Nevertheless, the longer interest rates remain elevated, the more pressure they will exert.”