With interest rates reaching their highest levels in over two decades and inflation pressing heavily on consumers, major banks are bracing for increased risks in their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all reported an increase in their provisions for credit losses compared to the previous quarter. These provisions represent the funds that financial institutions allocate to cover potential losses resulting from credit risks, including delinquent debts and loans, particularly in the commercial real estate sector.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses surged to $21.8 billion by the end of the quarter, more than tripling its reserve build from the prior quarter, and Wells Fargo had provisions totaling $1.24 billion.
These increased reserves suggest that banks are anticipating a more challenging environment in which both secured and unsecured loans could lead to larger losses. A recent analysis of household debt by the New York Federal Reserve indicated that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates have also been climbing as consumers deplete their pandemic savings and increasingly depend on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where the total surpassed the trillion-dollar threshold, according to TransUnion. Additionally, the commercial real estate sector remains vulnerable.
According to Brian Mulberry, a portfolio manager at Zacks Investment Management, the challenges confronting banks are likely to emerge in the coming months.
“The provisions reported at any given quarter do not necessarily reflect the credit quality of the last three months; rather, they indicate banks’ expectations for the future,” stated Mark Narron, a senior director with Fitch Ratings’ Financial Institutions Group. He noted the shift from a system where rising loan defaults led to increased provisions to one where macroeconomic forecasts dictate provisioning levels.
Banks are now anticipating slower economic growth, a rise in the unemployment rate, and the possibility of two interest rate cuts later this year in September and December, which could lead to more delinquencies and defaults by year’s end.
Citi’s chief financial officer, Mark Mason, observed that the distress signals appear to be particularly pronounced among lower-income consumers, who have seen their savings diminish since the pandemic.
“While the overall U.S. consumer remains resilient, we are observing varied performance and behavior based on income and credit scores,” Mason remarked during a recent analyst call. He highlighted that only the highest income quartile has managed to maintain greater savings than they had at the beginning of 2019, with consumers in the upper credit score bracket driving spending growth and keeping up with payments. In contrast, those with lower credit scores are facing more challenges, evidenced by declining payment rates and increased borrowing as they struggle with high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, as it awaits stabilization in inflation figures towards its 2% target before executing anticipated rate cuts.
Despite banks preparing for increased defaults in the latter half of the year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He is monitoring the distinction between homeowners and renters during this time.
“While interest rates have significantly risen, homeowners locked in very low fixed rates on their debts, so they aren’t experiencing much pain,” Mulberry explained. “Renters, on the other hand, missed that window of opportunity.”
Given that rental prices have surged over 30% nationwide from 2019 to 2023, alongside grocery costs climbing 25% in the same timeframe, renters who didn’t secure low rates are feeling the pressure on their budgets more acutely.
Currently, the overall conclusion from the latest round of earnings reports is that “there were no significant changes in asset quality this quarter,” Narron noted. Strong revenues, profits, and resilient net interest income continue to point to a healthy banking sector.
“There’s a positive strength within the banking sector that may not have been entirely unexpected, but it’s reassuring to confirm that the financial system remains robust and sound at this time,” Mulberry said. He cautioned, however, that the prolonged high-interest rate environment could lead to increasing stress for consumers and the banking sector alike.