As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks related to their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all raised their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks set aside to cover potential losses from credit risks, including bad debts and commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter. Bank of America allocated $1.5 billion, while Citigroup’s allowance grew to $21.8 billion, tripling its reserves from the prior quarter, and Wells Fargo added $1.24 billion in provisions.
These increased reserves signal that banks are preparing for a more challenging economic environment, where both secured and unsecured loans could lead to greater losses. A recent analysis by the New York Federal Reserve highlighted that Americans currently owe a combined $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise as many individuals exhaust their pandemic-era savings and increasingly turn to credit. As of the first quarter, credit card balances reached $1.02 trillion, marking the second consecutive quarter that totals have surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector remains particularly vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the economic landscape post-COVID, noting that stimulus measures significantly influenced consumer financial health.
However, potential problems for banks may arise in the coming months. Mark Narron, a senior director at Fitch Ratings, pointed out that provisions for credit losses do not necessarily reflect a bank’s recent credit quality; rather, they are based on expectations of future conditions.
In the short term, banks anticipate slowing economic growth, potentially rising unemployment, and expected interest rate cuts in September and December. This situation could lead to increasing delinquencies and defaults by the end of the year.
Citi’s chief financial officer, Mark Mason, has observed that the financial strain is particularly pronounced among lower-income consumers who have seen their savings diminish since the pandemic began. He stated that while the overall U.S. consumer remains resilient, there is a noticeable disparity in financial behavior across different income levels.
Mason noted that only the highest income quartile has managed to save more than at the start of 2019, with those in the over-740 FICO score category driving spending growth and maintaining high payment rates. In contrast, lower FICO score customers are experiencing sharper declines in payment rates and are borrowing more due to the challenges posed by high inflation and interest rates.
The Federal Reserve continues to maintain interest rates at a 23-year high of 5.25-5.5%, waiting for inflation to stabilize towards its 2% target before implementing anticipated rate cuts.
Despite preparations for increased defaults later in the year, Mulberry indicates that current default rates do not yet reflect a consumer crisis. He is particularly observing the divide between homeowners and renters, with homeowners having locked in low fixed rates, thus feeling less financial strain compared to renters facing rising housing costs.
With national rents increasing over 30% and grocery prices up 25% between 2019 and 2023, renters who did not secure low rates are feeling the most financial stress.
For now, the overall takeaway from the latest earnings reports is that there have been no new developments regarding asset quality. Strong revenues, profits, and resilient net interest income suggest that the banking sector remains healthy.
Mulberry expressed reassurances regarding the stability of the financial system but noted that persistent high interest rates could lead to increasing stress over time.