With interest rates reaching their highest levels in over 20 years and inflation pressing consumers, major banks are gearing up for increased risks linked to their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions to cover potential credit losses compared to the previous quarter. These provisions are funds set aside by financial institutions to manage expected losses from credit risks, including delinquent loans and commercial real estate debts.
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America reserved $1.5 billion; Citigroup’s total allowance for credit losses reached $21.8 billion, more than tripling from the prior quarter; and Wells Fargo set aside $1.24 billion.
The increase in provisions indicates that banks are preparing for a more challenging economic landscape, where both secured and unsecured loans could lead to larger losses. A recent analysis by the New York Federal Reserve revealed that American households collectively owe $17.7 trillion in consumer, student, and mortgage loans.
Moreover, the rise in credit card issuance and subsequent delinquency rates suggests that many consumers are exhausting their pandemic-era savings and relying more on credit. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter with totals exceeding one trillion dollars, according to TransUnion. The commercial real estate sector also remains in a vulnerable position.
“We’re still emerging from the COVID era, and much of the consumer banking health is attributed to the stimulus injected into the economy,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, challenges for banks are anticipated in the coming months.
“The provisions reported in any given quarter don’t necessarily reflect past credit quality but rather what banks anticipate for the future,” said Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
He added that the industry has shifted from a previous model where rising bad loans led to higher provisions, to one where macroeconomic forecasts are the primary driver for provisioning decisions.
In the near term, banks expect slowing economic growth, higher unemployment rates, and possible interest rate cuts in September and December, which could exacerbate delinquencies and defaults as the year concludes.
Citi CFO Mark Mason highlighted that these warnings are mainly affecting lower-income consumers, who have seen their savings diminish since the pandemic.
“While the overall U.S. consumer remains resilient, we’re seeing a divergence in performance across income levels and credit scores,” Mason noted in a recent analyst call.
He observed that only the highest-income quartile has maintained more savings than before 2019, with consumers in the top FICO score range driving spending growth and keeping high payment rates. In contrast, lower FICO score customers are experiencing greater declines in payment rates, borrowing more as they struggle with inflation and high-interest rates.
The Federal Reserve is keeping interest rates at a 23-year high of 5.25-5.5% as it waits for inflation to stabilize towards its 2% target before enacting anticipated rate cuts.
Despite preparations for increased defaults later in the year, current rates of defaults do not indicate a consumer crisis, according to Mulberry. He is particularly monitoring the distinction between homeowners and renters during the pandemic.
“While interest rates have risen significantly, homeowners benefitted from locking in low fixed rates and are not feeling the financial strain as acutely,” Mulberry explained. “Conversely, renters who faced rising rents and stagnant wages during that time are experiencing the most budgetary stress.”
The latest earnings reports suggest that there were no significant new concerns regarding asset quality this quarter. The strong revenues, profits, and resilient net interest income indicate a healthy banking sector.
“There is evidence of strength in the banking sector, which may not be entirely surprising but certainly assures us that the financial system remains robust,” Mulberry concluded. “However, we must remain vigilant, as prolonged high interest rates will likely introduce more strain.”