Amidst interest rates reaching levels not seen in over two decades and persistent inflation affecting consumers, major banks are bracing for increased risks associated with their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their provisions for credit losses compared to the previous quarter. These provisions are funds that banks allocate to cover potential losses from credit risks such as defaults on loans, including commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses totaled $21.8 billion at the end of the quarter, tripling its reserves from the previous quarter, and Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans could lead to sizable losses for these financial institutions. Recent analysis from the New York Fed revealed that American households carry a debt load of $17.7 trillion across consumer loans, student loans, and mortgages.
Moreover, the issuance of credit cards and rates of delinquency are also on the rise as individuals exhaust their pandemic-era savings and increasingly rely on credit. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total balances surpassed the trillion-dollar threshold. Commercial real estate also remains vulnerable.
“We’re still navigating the aftereffects of the COVID era, particularly regarding banking and consumer health, which were primarily supported by stimulus directed towards consumers,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Nonetheless, any challenges for banks will likely emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that quarterly provisions do not necessarily reflect credit quality from the preceding three months; rather, they signal banks’ expectations for future conditions.
He explained, “It’s interesting because we’ve transitioned from a system where provisions increased as loans went bad, to one where macroeconomic forecasts significantly influence provisioning.”
Short-term projections from banks indicate expectations of slower economic growth, rising unemployment, and anticipated interest rate cuts in September and December, which could lead to increased delinquencies and defaults as the year closes.
Mark Mason, Citi’s chief financial officer, highlighted concerns focused on lower-income consumers who have seen their savings diminish since the pandemic.
“While we observe an overall resilient U.S. consumer, there is noticeable divergence in performance based on income and credit scores,” Mason remarked in a recent analyst call.
He added, “Only the highest income quartile has more savings than at the start of 2019, and it is those with a FICO score above 740 driving spending growth and adhering to high payment rates. Conversely, customers with lower FICO scores are experiencing significant drops in payment rates and are borrowing more, chiefly affected by rising inflation and interest rates.”
The Federal Reserve continues to maintain interest rates at a historic high of 5.25-5.5%, awaiting signs of stabilization in inflation toward the central bank’s 2% target before implementing anticipated rate cuts.
Despite the banks’ preparations for rising defaults later this year, Mulberry suggested that current default rates do not indicate a consumer crisis. He is particularly watching the contrasting situations of homeowners and renters since the pandemic.
While mortgage rates have risen significantly, homeowners benefitted from locking in very low fixed rates, so they have not felt as much financial pressure, according to Mulberry. On the other hand, renters, who did not secure low rates, face steep rent increases—over 30% nationally between 2019 and 2023—alongside grocery costs rising by 25% in the same period, leading to heightened stress on their budgets.
Overall, the recent earnings reports signal that there is “nothing new this quarter in terms of asset quality,” according to Narron. Robust revenues, profits, and resilient net interest income demonstrate a strong banking sector.
“There is some strength within the banking system that was not entirely unexpected, but it is reassuring to note that the financial structures remain solid and sound at this time,” Mulberry concluded. “However, we remain vigilant; the prolonged period of high interest rates inevitably brings more strain.”