As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks related to 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 from credit risks, including issues with delinquent debt and various types of loans such as commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses, while Bank of America set aside $1.5 billion. Citigroup’s allowance reached $21.8 billion by the end of the quarter, marking a more than threefold increase in credit reserves from the previous quarter. Wells Fargo reported provisions of $1.24 billion.
The increase in provisions indicates that banks are preparing for a challenging financial landscape, where both secured and unsecured loans could lead to substantial losses. A recent New York Fed analysis highlighted that American households are collectively carrying $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, rising credit card issuance and delinquency rates reflect consumers exhausting their pandemic-era savings and increasingly relying on credit. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold, as reported by TransUnion. The commercial real estate sector also remains in a delicate state.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, emphasized the ongoing adjustments following the COVID era, particularly regarding banking and consumer health, which were significantly influenced by stimulus measures.
However, challenges for banks are anticipated in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that the provisions reported in any quarter do not always reflect credit quality from the preceding months but instead foreshadow future expectations.
As banks foresee slowing economic growth, a rise in unemployment, and potential interest rate reductions later this year, they are preparing for increased delinquencies and defaults by year-end.
Citi’s chief financial officer Mark Mason pointed out concerning trends primarily affecting lower-income consumers, whose savings have diminished since the pandemic began. He observed a divergence in consumer behavior based on income and credit scores.
Mason stated, “Although the overall U.S. consumer remains resilient, there is a clear difference in financial performance across different FICO score and income groups.” He noted that only the highest income quartile has managed to retain savings since early 2019, with those holding high credit scores continuing to spend and pay reliably. Conversely, lower credit score individuals are struggling more with payment rates and increasing borrowing, significantly impacted by high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year peak of 5.25-5.5%, awaiting inflation indicators to stabilize toward the 2% target before implementing anticipated rate cuts.
Despite bank preparations for potential defaults later this year, Mulberry pointed out that current default rates do not indicate an imminent consumer crisis. He highlighted a significant contrast between homeowners, who typically locked in low fixed rates during the pandemic, and renters, who are now facing significant cost challenges.
With rent prices rising over 30% nationwide between 2019 and 2023 and grocery costs increasing 25% in that same timeframe, renters without access to favorable rates are encountering considerable strain on their budgets.
For the present, industry analysts concluded that recent earnings indicate stability within the banking sector, noting that strong revenues and interest income remain positive signs. Mulberry remarked on the resilience of the financial system, despite the ongoing pressures caused by sustained high interest rates.