With interest rates reaching their highest levels in over two decades and inflation putting pressure on 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 increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks set aside to cover potential losses from issues like delinquent debts and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit loss provisions, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses rose to $21.8 billion, more than tripling its reserves from the previous quarter, and Wells Fargo accounted for $1.24 billion in provisions.
These increased provisions indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans may result in larger losses for these financial institutions. A recent evaluation of household debt by the New York Federal Reserve revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
There has also been a rise in credit card issuance and delinquency rates as consumers deplete their pandemic-era savings and increasingly depend on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. Additionally, commercial real estate remains in a delicate situation.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, emphasized that the current phase still reflects the transition from the COVID-19 era, pointing to the stimulus measures that were provided to consumers.
Experts warn that any financial issues for banks may surface in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that the provisions reported quarterly typically do not indicate past credit quality but instead reflect banks’ expectations for the future.
Currently, banks anticipate slower economic growth, a potential increase in the unemployment rate, and two expected interest rate reductions later this year, which could lead to a rise in delinquencies and defaults.
Citi’s CFO, Mark Mason, highlighted that indications of trouble are mostly seen among lower-income consumers, who have noticeably depleted their savings since the pandemic.
While Mason acknowledged there is overall resilience in the U.S. consumer market, he pointed out significant disparities in performance across income levels. Only the highest income quartile has more savings now than at the beginning of 2019, with consumers possessing FICO scores above 740 driving spending growth and maintaining good payment rates. In contrast, customers in lower FICO brackets are experiencing faster declines in payment rates and are borrowing more due to the strain of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation metrics towards the central bank’s 2% target before implementing the anticipated rate cuts.
Despite banks gearing up for potential defaults in the latter part of the year, current trends do not indicate an imminent consumer crisis. Mulberry noted that property owners who secured low-fixed rates during the pandemic are not feeling the financial strain compared to renters, who are facing increased costs.
With rents surging over 30% nationally between 2019 and 2023 and grocery prices rising by 25% in that time frame, renters who did not benefit from low-rate locks are facing significant budgeting pressures.
Overall, the latest earnings reports reveal no new concerns regarding asset quality, with strong revenues and profits indicating ongoing health in the banking sector. Mulberry stated that the robustness of the financial system remains reassuring, though ongoing high interest rates are likely to create more stress over time.