With interest rates at their highest levels in over 20 years and inflation continuing to impact consumers, major banks are bracing for increased risks associated with their lending operations.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for potential credit losses compared to the previous quarter. These provisions represent funds that banks reserve to offset possible losses from credit risk, including defaulted loans and issues with commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s allowance for credit losses reached $21.8 billion, more than tripling its reserves from the prior quarter; and Wells Fargo noted provisions of $1.24 billion.
These heightened reserves indicate that banks are preparing for a more challenging financial landscape. Recent data from the New York Federal Reserve reveals that Americans currently owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Furthermore, credit card issuance and delinquency rates are climbing as individuals tap into their savings from the pandemic. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter in which total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also remains in a vulnerable position.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the financial health of consumers is still recovering from the COVID-19 period, which was largely supported by government stimulus efforts.
However, challenges for banks are expected to emerge in the coming months.
“The provisions seen in any given quarter don’t solely reflect past credit quality, but rather what banks anticipate for the future,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He added, “It’s noteworthy that we’ve shifted from a system where rising loan defaults would increase provisions to one where macroeconomic forecasts are the primary drivers.”
In the short term, banks are predicting slower economic growth, a rise in unemployment, and potential interest rate cuts in September and December of this year, which could lead to an increase in delinquencies and defaults.
Citi’s Chief Financial Officer Mark Mason highlighted that these warning signs seem predominantly to affect lower-income consumers, who have depleted much of their savings since the pandemic.
“While the overall U.S. consumer appears resilient, there is a noticeable disparity in performance and behavior based on income and credit scores,” Mason stated in a recent analysts’ call. He emphasized that only the top income quartile has managed to increase their savings since early 2019, with higher credit score customers driving spending growth and maintaining payment reliability. Conversely, those with lower credit scores are experiencing a decline in payment regularity and are borrowing more, facing greater challenges from high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it awaits stabilization in inflation metrics toward its 2% target before enacting anticipated rate cuts.
Despite banks preparing for more defaults in the latter part of the year, analysts indicate that current default rates do not signal an impending consumer crisis. Mulberry is particularly attentive to the differences between homeowners and renters during this period.
“Although rates have significantly increased, homeowners benefitted from locking in low fixed rates on their mortgages, so they are not feeling the financial strain as much,” Mulberry noted. He contrasted this with renters who have faced rental increases surpassing wage growth, with rents up over 30% nationally from 2019 to 2023 and grocery costs rising 25%.
For now, the latest earnings reports suggest that there are “no new significant issues regarding asset quality,” according to Narron. Strong revenues, profits, and robust net interest income continue to indicate a healthy banking sector.
“There is a resilience in the banking industry that may have been somewhat unexpected, but it is reassuring to acknowledge that the foundations of the financial system remain solid,” Mulberry remarked. However, he cautioned that sustained high interest rates may lead to increased financial strain over time.