Amid more than two decades of high interest rates 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 represent funds set aside by banks to cover potential losses related to delinquent accounts and bad debts, including commercial real estate loans.
Specifically, JPMorgan allocated $3.05 billion for credit loss provisions; Bank of America set aside $1.5 billion; Citigroup reported a total of $21.8 billion in credit loss allowances, which saw more than a threefold increase from the previous quarter; and Wells Fargo reported provisions of $1.24 billion.
These increases signal that banks are preparing for a riskier lending environment, where both secured and unsecured loans could result in greater losses. A recent analysis by the New York Fed indicated that American households are carrying a total of $17.7 trillion in debt across consumer, student, and mortgage loans.
Additionally, the issuance of credit cards and delinquency rates are rising as many consumers exhaust their pandemic-era savings and turn to credit for financial support. Credit card debt reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total balances exceeded this threshold, according to TransUnion. Meanwhile, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking and consumer health dynamics have changed significantly since the pandemic, heavily influenced by government stimulus measures.
Any potential challenges for banks are expected to unfold in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported quarterly do not necessarily reflect recent credit quality but rather banks’ expectations for future performance.
Narron added that economic forecasts suggest slower growth, higher unemployment, and anticipated interest rate cuts in September and December, all of which could lead to increased delinquencies and defaults as the year progresses.
Citi’s CFO, Mark Mason, pointed out concerning trends primarily among lower-income consumers, who have seen their savings diminish since the pandemic. He emphasized the disparity in financial resilience, noting that only the highest income quartile has been able to maintain savings since early 2019.
While creditworthiness varies across income groups, it’s notable that higher FICO score customers are driving spending growth and consistent payment rates. Conversely, customers in lower FICO bands are experiencing declining payment rates and are relying more on borrowing amid rising inflation and interest pressures.
The Federal Reserve has maintained interest rates at their highest level in 23 years, at 5.25% to 5.5%, awaiting stabilization in inflation towards the central bank’s 2% target before proceeding with expected rate cuts.
Despite banks’ preparations for a surge in defaults in the latter half of the year, industry experts maintain that default rates have yet to indicate an impending consumer crisis. Mulberry highlighted the contrasting experiences of homeowners versus renters, noting that while interest rates have increased, many homeowners benefitted from locking in low fixed rates, shielding them from significant financial strain.
With rents surging over 30% nationwide from 2019 to 2023 and grocery prices rising 25% in the same period, renters lacking those advantages may experience heightened financial stress.
Overall, the most recent earnings reports showcase that the banking sector remains robust, with strong revenues, profits, and solid net interest income, according to Narron. Mulberry added that the continuing strength of the financial system offers reassurance, although the prolonged high interest rates may eventually lead to more stress for the sector.