As interest rates hit levels not seen in over two decades and inflation continues to impact consumers, major banks are bracing for potential risks from 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 funds set aside by banks to mitigate potential losses from credit risk, which includes bad debts and lending activities like commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, marking more than a threefold increase from the previous quarter. Wells Fargo’s provisions amounted to $1.24 billion.
This increase indicates that banks are preparing for a more challenging environment where both secured and unsecured loans could lead to greater losses. A recent report from the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as consumers deplete their pandemic-era savings and increasingly rely on credit. Credit card balances rose to $1.02 trillion in the first quarter of the year, marking the second consecutive quarter where total card balances surpassed the trillion-dollar mark, according to TransUnion. Additionally, the commercial real estate sector remains in a tenuous position.
“We are still navigating the aftermath of the COVID era, especially concerning banking and consumer health, largely due to the stimulus measures that were implemented,” remarked Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, challenges for banks are anticipated in the coming months.
“The provisions reported in each quarter do not necessarily mirror credit quality for the past three months; they reflect banks’ expectations of future developments,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He noted a shift in the banking landscape; historically, provisions would increase as loans began to default, but now, macroeconomic forecasts significantly influence provisioning decisions.
Banks are currently projecting slowing economic growth, rising unemployment, and the potential for two interest rate cuts later this year in September and December, which could lead to more delinquencies and defaults by year-end.
Citigroup’s Chief Financial Officer Mark Mason noted that these warning signs seem particularly prevalent among lower-income consumers, who have seen their savings decline since the pandemic.
“While the overall U.S. consumer remains resilient, there is a noticeable difference in performance and behavior among various income levels,” Mason stated during an analyst call earlier this month. “Only the highest income quartile has more savings than they did in early 2019, and customers with scores over 740 are the ones contributing to spending growth while maintaining high payment rates. In contrast, those with lower credit scores are experiencing greater payment difficulties and are borrowing more due to the pressures from high inflation and interest rates.”
The Federal Reserve continues to maintain interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation towards the central bank’s 2% target before initiating anticipated rate cuts.
Despite banks preparing for increased defaults in the latter part of the year, defaults have not yet escalated to levels indicating a consumer crisis, according to Mulberry. He is particularly observing the differences between homeowners and renters during the pandemic.
“While rates have significantly increased, homeowners locked in low fixed rates on their debts and are not feeling the financial strain as acutely,” Mulberry noted. “Conversely, renters have missed out on this opportunity.”
With rental prices surging over 30% nationally from 2019 to 2023, and grocery costs rising by 25%, renters are facing considerable challenges as their expenses have outpaced wage growth.
For the time being, the key insight from the latest round of earnings reports is that there have been no major changes in asset quality. In fact, robust revenues, profits, and steady net interest income signal a still-healthy banking sector.
“There’s a degree of strength in the banking industry that, while perhaps not entirely unexpected, serves as a reassurance that the financial system’s structures remain strong and sound at this point,” Mulberry stated. “However, we are closely monitoring the situation, as prolonged high interest rates could lead to increased stress on consumers.”