As interest rates reach their highest levels in over 20 years and inflation continues to pressure 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 all increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds set aside by financial institutions to cover potential losses arising from credit risks, including unpaid debts and lending related to commercial real estate.
JPMorgan raised its provision for credit losses to $3.05 billion in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s credit loss allowance reached $21.8 billion by the end of the quarter, more than tripling its previous reserves, and Wells Fargo reported provisions of $1.24 billion.
These increases signal that banks are preparing for a more challenging lending environment, where both secured and unsecured loans could lead to greater losses. A recent analysis by the New York Fed revealed that Americans owe $17.7 trillion collectively in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as individuals deplete their pandemic-related savings and increasingly rely on credit. In the first quarter of this year, total credit card balances reached $1.02 trillion, marking the second consecutive quarter when these balances surpassed the trillion-dollar threshold, according to TransUnion. Additionally, the commercial real estate sector faces significant uncertainty.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted, “We’re still coming out of this COVID era, particularly concerning banking and consumer health, which was significantly influenced by the stimulus provided to consumers.”
However, banks anticipate potential difficulties in the coming months. Mark Narron, a senior director at Fitch Ratings, explained, “The provisions reported in any quarter don’t just reflect recent credit quality; they are based on what banks expect will happen in the future.”
He added that there has been a shift from a historical system where provisions would rise in response to bad loans, to one driven by macroeconomic forecasts.
Currently, banks predict a slowdown in economic growth, a rise in unemployment, and two interest rate cuts anticipated later this year in September and December. This trend could lead to an increase in delinquencies and defaults as the year concludes.
Citigroup’s chief financial officer, Mark Mason, noted that warning signs are particularly evident among lower-income consumers, who have seen their savings diminish since the pandemic.
Mason indicated, “While the overall U.S. consumer remains resilient, we observe a divergence in performance and behavior across different income levels and credit scores.” He highlighted that only the highest income quartile has more savings than they did at the beginning of 2019, and that customers with higher credit scores are leading in spending growth and maintaining payment rates.
Meanwhile, the Federal Reserve has maintained interest rates at a range of 5.25-5.5%, which is at a 23-year high, as it awaits evidence of inflation stabilizing to its 2% target before enacting anticipated rate cuts.
Despite the banks’ preparations for an increase in defaults in the latter part of the year, Mulberry stated that current default rates do not indicate an impending consumer crisis. He is particularly focused on the differences between homeowners and renters who navigated the pandemic differently.
He pointed out that, while interest rates have surged, homeowners benefitted from locking in low fixed rates on their mortgages, sparing them from significant pain. In contrast, renters, who did not secure such benefits, are facing rising rental costs amid soaring inflation.
Rents have increased over 30% nationwide from 2019 to 2023, while grocery expenses rose by 25%, stressing the budgets of renters who are not experiencing corresponding wage growth.
Ultimately, the latest round of earnings reports suggests that there were no substantial new developments in asset quality. Positive indicators for the banking sector include strong revenues, profits, and resilient net interest income.
Mulberry concluded that while there is strength in the banking sector, which is reassuring, prolonged high interest rates will likely increase stress within the system.