As interest rates reach levels not seen in over two decades and inflation remains a burden for consumers, major banks are preparing for increased risks in their lending operations.
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, which are funds set aside to address potential losses related to credit risk, including bad debt and risks from lending, particularly in commercial real estate, highlight the banks’ cautious stance in a more challenging economic environment.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses surged to $21.8 billion at the end of the quarter, more than tripling from the previous quarter. Similarly, Wells Fargo reported provisions of $1.24 billion.
These increased reserves suggest that banks are preparing for a riskier lending atmosphere, where both secured and unsecured loans might lead to larger losses. According to a recent report by the New York Federal Reserve, total household debt in the U.S. has reached $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
There is also a notable rise in credit card issuance and delinquency rates, as many consumers exhaust their savings from the pandemic and increasingly rely on credit. During the first quarter of this year, credit card balances hit $1.02 trillion, marking the second consecutive quarter that total cardholder balances surpassed the trillion-dollar threshold. The commercial real estate sector remains a particular concern.
Experts indicate that the ongoing recovery from the pandemic, coupled with the effects of economic stimulus, is impacting consumer behavior. Brian Mulberry, a client portfolio manager at Zacks Investment Management, emphasized the importance of understanding the situation beyond current metrics.
“The provisions reported in any given quarter do not solely reflect past credit quality; instead, they indicate banks’ expectations for the future,” stated Mark Narron, a senior director at Fitch Ratings. He noted the shift from a historical model, where rising defaults prompted larger provisions, to a forward-looking system influenced by macroeconomic forecasts.
Looking ahead, banks are bracing for a slowdown in economic growth, a potential rise in unemployment, and anticipated interest rate cuts later this year. This could lead to more delinquencies and defaults as 2023 concludes.
Citi’s CFO Mark Mason pointed out that warning signs are particularly prominent among lower-income consumers, who have faced significant declines in savings post-pandemic. “While the overall U.S. consumer remains resilient, we see varying performance levels across different income and FICO score groups,” Mason explained during a recent analyst call. He noted that only the top income quartile has increased savings since early 2019, with consumers boasting higher credit scores driving spending growth, whereas those with lower credit scores experience more financial strain.
The Federal Reserve currently maintains interest rates at a high of 5.25-5.5% as it awaits stabilization in inflation rates towards its target of 2% before proceeding with expected rate cuts.
Despite these preparations for a potential rise in defaults, current data do not signal an impending consumer crisis, according to Mulberry. He highlighted the distinctions between homeowners who secured low fixed mortgage rates and renters facing significant financial pressure from skyrocketing rents.
“The increase in rates has affected new borrowers, but those who were homeowners during the pandemic still benefit from low fixed rates,” Mulberry noted. In contrast, renters have faced rent increases exceeding 30% from 2019 to 2023 alongside a 25% rise in grocery costs, leading to considerable stress on their monthly finances.
The latest earnings reports suggest that the banking sector remains generally healthy, with no significant new issues related to asset quality. “Strong revenues and profits indicate resilience within the sector,” Narron mentioned. Mulberry also emphasized that despite current strength, vigilance is necessary as prolonged high-interest rates could introduce more stress in the future.