As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, large banks are bracing for potential risks linked 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 funds set aside by financial institutions to cover possible losses due to credit risks, which include delinquent loans and distressed real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America earmarked $1.5 billion. Citigroup reported an allowance for credit losses of $21.8 billion, significantly increasing its reserves, and Wells Fargo set aside $1.24 billion in provisions.
This accumulation of provisions underscores banks’ preparations for a potentially riskier lending landscape, where both secured and unsecured loans could lead to greater financial losses. A recent report on household debt from the New York Federal Reserve highlighted that Americans owe approximately $17.7 trillion in various consumer loans, including student loans and mortgages.
Credit card usage is also increasing, accompanied by rising delinquency rates as consumers deplete their pandemic savings and turn to credit more frequently. By the first quarter of this year, total credit card balances reached $1.02 trillion, marking the second consecutive quarter where combined cardholder balances surpassed the trillion-dollar threshold. The commercial real estate sector appears to be in a particularly vulnerable state as well.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking sector’s outlook on consumer health remains influenced by previous stimulus measures. “We’re still recovering from the COVID era, particularly regarding consumer banking and overall economic health,” he noted.
However, the ramifications for banks are expected in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported quarterly do not solely reflect recent credit quality but rather banks’ anticipations for future conditions.
“The shift has occurred from a historical perspective where rising loan defaults drove up provisions to a current system largely influenced by macroeconomic forecasts,” Narron stated.
In the short term, banks foresee slowing economic growth, increasing unemployment rates, and two scheduled interest rate cuts later this year, which may lead to more delinquencies and defaults as the year progresses.
Citigroup’s CFO Mark Mason pointed out that financial challenges seem to be more pronounced among lower-income consumers, who have seen their savings decline since the pandemic began. He stated that only the highest income quartile has more savings than that of early 2019, with those in the over-740 FICO score group leading spending growth and maintaining strong payment rates. In contrast, lower-FICO customers are struggling with payment rates and increased borrowing due to inflation and rising interest rates’ impacts.
The Federal Reserve has maintained interest rates between 5.25% to 5.5%, their highest in 23 years, while it observes inflation trends aligning more closely with its 2% target before implementing anticipated rate cuts.
Despite banks’ readiness for a rise in defaults later this year, current default rates do not indicate a consumer crisis, according to Mulberry. He noted the division between those who owned homes during the pandemic and those who rented. “Homeowners secured low fixed rates on their debts, causing them not to feel the strain as much,” he explained, contrasting their experience with renters who have faced significant increases in housing costs.
With nationwide rents jumping over 30% from 2019 to 2023, and grocery prices climbing 25%, renters who couldn’t lock in favorable rates are experiencing higher budget stress, according to Mulberry.
For the time being, analysts have concluded that there were no surprising developments in asset quality during the latest earnings reporting period. The outlook remains positive, with healthy revenues, profits, and net interest income all signaling a robust banking sector.
“There remains strength in the banking sector, alleviating concerns about the financial system’s structure, which currently appears strong and sound,” Mulberry noted, while also emphasizing vigilance as long-term high interest rates could continue to exert stress.