As interest rates reach their highest levels in over 20 years and inflation continues to pressure consumers, major banks are preparing for potential risks in their lending activities.
During 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 reserves that banks allocate to cover potential losses from credit risk, such as delinquent debts and commercial real estate loans.
Specifically, JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses surged to $21.8 billion, significantly higher than the previous quarter, and Wells Fargo established provisions totaling $1.24 billion.
These increases indicate that banks are bracing for a more challenging environment where both secured and unsecured loans could lead to greater losses. A recent analysis by the New York Federal Reserve revealed that Americans owe a staggering $17.7 trillion across consumer loans, student loans, and mortgages.
Moreover, credit card usage and delinquency rates are also on the rise as consumers exhaust their pandemic savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that balances exceeded the trillion-dollar threshold, according to TransUnion. Additionally, the commercial real estate sector remains uncertain.
“We’re still emerging from the COVID era, particularly in terms of banking and consumer health, which was heavily supported by stimulus efforts,” explained Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any significant issues for banks may manifest in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that current provisions do not solely reflect recent credit quality but also banks’ forecasts for the future.
“It’s a shift from the past where rising defaults prompted higher provisions to a system where macroeconomic predictions are crucial for provisioning,” Narron remarked.
Short-term projections indicate slowing economic growth, an uptick in unemployment, and anticipated interest rate cuts later this year, which could lead to increased delinquencies and defaults.
Citi’s Chief Financial Officer Mark Mason highlighted that emerging concerns are primarily affecting lower-income consumers, who have seen their savings decline since the pandemic. He pointed out that only the highest income quartile has more savings now than at the beginning of 2019, and it is primarily those with high FICO scores who are maintaining spending and payment rates.
The Federal Reserve currently keeps interest rates at a range of 5.25-5.5%, the highest in 23 years, as it seeks signs of inflation stabilizing around its 2% target before implementing the expected rate cuts.
While banks are preparing for heightened defaults later in the year, Mulberry noted that current default rates do not indicate an impending consumer crisis. He emphasized the difference in experiences between homeowners and renters, stating that while rates have risen, homeowners with fixed-rate mortgages are largely insulated from immediate financial distress.
In contrast, renters, who did not benefit from lower home loan rates, are facing significant financial strains due to rising rents and grocery prices, which have increased by over 30% and 25%, respectively, between 2019 and 2023.
Overall, the latest earnings reports reveal that “there was nothing new this quarter in terms of asset quality,” according to Narron. Strong revenues, profits, and net interest income indicate that the banking sector remains robust, although concerns about prolonged high interest rates persist.
“There is some resilience in the banking sector that may not have been completely anticipated; it’s reassuring to see that the fundamental structures of the financial system are still solid,” Mulberry concluded. “However, we are closely monitoring the situation, as long-term high interest rates could induce further stress.”