As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks stemming from their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all heightened their provisions for credit losses compared to the previous quarter. These provisions represent funds that banks allocate to cover potential losses related to credit risks, such as delinquent loans and bad debts, including commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup reported an allowance for credit losses of $21.8 billion, which more than tripled from the previous quarter, and Wells Fargo put aside $1.24 billion.
These increased provisions indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans could lead to greater losses. According to a recent report by the New York Fed, the total household debt in the U.S. stands at a staggering $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also climbing as consumers exhaust their pandemic-era 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 mark, according to TransUnion. The position of commercial real estate remains particularly vulnerable.
“We’re still navigating the aftermath of the COVID era, especially concerning banking and consumer health, largely due to the stimulus that was provided,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, challenges for banks are more likely to manifest in the upcoming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that current provisions do not necessarily reflect the credit quality from recent months but rather banks’ expectations for future conditions.
As banks anticipate slowing economic growth, elevated unemployment rates, and potential interest rate cuts in September and December, there could be an uptick in delinquencies and defaults by the close of the year.
Citi’s chief financial officer Mark Mason highlighted that concerns seem to be concentrated among lower-income consumers, who have seen their savings diminish significantly since the pandemic.
“While we observe an overall resilient U.S. consumer, there’s noticeable divergence in performance and behavior across different income levels and credit scores,” Mason remarked during an analyst call. He pointed out that only the highest-income quartile has retained more savings than at the beginning of 2019, with customers boasting credit scores over 740 driving spending growth and maintaining high payment rates. In contrast, those with lower credit scores are experiencing greater difficulties, with increased borrowing and declining payment rates due to the impact of high inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, waiting for inflation indicators to stabilize around the 2% target before implementing expected rate cuts.
Despite preparations for increased defaults in the latter part of the year, defaults have not surged to a level suggesting a consumer crisis at this point, according to Mulberry. He is particularly observing the divide between homeowners and renters during the pandemic.
While interest rates have increased significantly, homeowners who secured low fixed rates on their mortgages are largely shielded from financial strain, unlike renters who missed out on these opportunities.
With rental prices rising over 30% nationwide from 2019 to 2023 and grocery costs increasing by 25% in that timeframe, renters without low-rate agreements are facing significant pressure on their budgets.
For now, analysts note that the most recent earnings report indicates there are no new concerns regarding asset quality. Strong revenue figures, profits, and resilient net interest incomes are signs of a still-healthy banking sector.
“There’s a strength in the banking sector that may not have been entirely anticipated, but it’s reassuring to confirm that the financial system remains robust and sound at this time,” Mulberry concluded. “However, we are closely monitoring the situation; the longer interest rates remain elevated, the more stress they may impose.”