As interest rates reach their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for potential risks in their lending activities.
In the second quarter of this year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. Provisions are funds set aside by financial institutions to cover potential losses stemming from credit risks, including bad debts and lending issues, particularly in the commercial real estate sector.
JPMorgan allocated $3.05 billion for credit losses during the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses was reported at $21.8 billion, marking more than a triple increase from the previous quarter. Wells Fargo reported provisions of $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. The New York Federal Reserve recently revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are on the rise as consumers deplete their savings accumulated during the pandemic and turn increasingly to credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where combined cardholder balances surpassed the trillion-dollar mark, as reported by TransUnion. The commercial real estate sector is also experiencing uncertainty.
“The impact of the COVID-19 era continues to be felt in banking and consumer health, primarily due to the stimulus measures that were introduced,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Experts warn that any challenges for banks may arise in the coming months. “Provisions observed in any given quarter do not necessarily mirror the actual credit quality of the past three months; instead, they reflect what banks predict will happen in the future,” said Mark Narron, a senior director at Fitch Ratings.
“We are transitioning from a system where provisions increased as loans started to falter to one where macroeconomic forecasts are what drive provisions,” he explained.
In the short term, banks anticipate slowing economic growth, rising unemployment, and two anticipated interest rate cuts later this year, which could lead to more delinquencies and defaults by year-end.
Citigroup’s chief financial officer Mark Mason highlighted that warning signs are particularly evident among lower-income consumers, who have seen their savings diminish since the pandemic. “While the overall U.S. consumer shows resilience, we observe a disparity in performance and behavior among different income levels and credit scores,” Mason remarked during a recent analyst call.
“Only the highest income quartile has more savings than at the beginning of 2019, with those having a FICO score above 740 driving both spending growth and high payment rates. In contrast, lower FICO customers are experiencing greater drops in payment rates and are borrowing more heavily, impacting them more acutely due to rising inflation and interest rates,” he noted.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25% to 5.5%, waiting for inflation to stabilize towards their 2% target before implementing anticipated cuts.
Despite banks’ preparations for increased defaults in the latter half of the year, current data does not suggest an impending consumer crisis, according to Mulberry. He is currently observing the divide between homeowners and renters during the pandemic.
“While interest rates have risen significantly, homeowners reaped the benefits of locking in very low fixed rates, so they are not feeling the impact as much. Renters, on the other hand, didn’t have that opportunity,” Mulberry explained.
With rent prices increasing over 30% across the nation between 2019 and 2023, alongside a 25% rise in grocery costs during the same period, renters are facing notable stress in their monthly budgets, according to Mulberry.
For the time being, the main takeaway from the latest earnings reports is that overall asset quality has remained stable. There are strong revenues, profits, and a resilient net interest income, all signaling a currently healthy banking sector.
“There’s a degree of strength within the banking sector that wasn’t entirely unexpected, but it is reassuring to see that the financial system remains robust,” Mulberry concluded. “However, we are closely monitoring the situation, as prolonged high-interest rates could lead to increased strain.”