As interest rates remain at their highest levels in over two decades and inflation continues to challenge consumers, major banks are bracing for increased risks associated with 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 banks set aside to cover potential losses associated with credit risks, including defaulted debts and lending, particularly commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, more than tripling its reserves from the prior quarter. Wells Fargo prepared provisions amounting to $1.24 billion.
The accumulation of reserves indicates that banks are preparing for a more challenging financial landscape where both secured and unsecured loans may result in larger losses. Recent data from the New York Fed revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card usage and delinquency rates are also climbing as consumers deplete their pandemic savings and rely increasingly on credit. Credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. The commercial real estate sector, in particular, remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented, “We’re still emerging from the COVID period, and a significant factor influencing the banking sector and consumer health has been the stimulus provided to consumers.”
Potential problems for banks may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that the provisions observed in any quarter reflect banks’ expectations for future credit quality rather than past performance.
“It’s noteworthy how we’ve shifted from a system where poor loan performance increased provisions to one where macroeconomic forecasts heavily influence provisioning,” he explained.
Banks anticipate slowing economic growth, a rising unemployment rate, and interest rate cuts later this year in September and December, which could lead to more delinquencies and defaults toward year-end.
Citi CFO Mark Mason highlighted that these warning signs are primarily evident among lower-income consumers, who have seen their savings diminish since the pandemic. While the overall U.S. consumer remains resilient, there is a noticeable divergence in financial performance among different income and credit score groups.
Only consumers in the highest income bracket have managed to increase their savings since early 2019, according to Mason. He remarked, “Lower FICO band customers are experiencing more significant drops in payment rates and are borrowing more as they are more severely affected by the high inflation and interest rates.”
The Federal Reserve has maintained interest rates between 5.25% and 5.5%, the highest in 23 years, as it awaits inflation measures to move closer to the central bank’s 2% target before implementing significant rate cuts.
Despite banks bracing for a rise in defaults later this year, the current default rates do not suggest an imminent consumer crisis, Mulberry stated. He is particularly observing the contrast between homeowners and renters from the pandemic period.
Homeowners, who secured low fixed rates, are less impacted by rising rates, unlike renters who have had to cope with increased rental prices. Nationwide, rents have surged over 30% from 2019 to 2023, with grocery costs rising by 25% in the same period. Renters who missed the opportunity to lock in low rates are facing significant financial pressure.
For now, the latest earnings reports indicate that there are no significant new concerns regarding asset quality. Strong revenues, profits, and stable net interest income remain positive signs for the banking sector.
Mulberry concluded that while some strength in the banking system is encouraging, the prolonged high interest rates may continue to exert pressure on financial institutions moving forward.