With interest rates at their highest levels in over two decades and persistent inflation affecting 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 raised their provisions for credit losses compared to the previous quarter. These provisions are funds set aside by financial institutions to cover potential losses from credit risk, which includes delinquent debts and lending practices, such as commercial real estate loans.
JPMorgan increased its provision for credit losses by $3.05 billion in the second quarter, 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, tripling its reserves from the previous quarter, and Wells Fargo had provisions totaling $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging environment where both secured and unsecured loans may lead to larger losses. A recent analysis from the New York Fed revealed that Americans collectively owe $17.7 trillion on various types of consumer loans, including student loans and mortgages.
Moreover, credit card issuance and delinquency rates are rising as consumers deplete their pandemic savings and increasingly turn to credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter in which balances exceeded one trillion dollars, according to TransUnion. The commercial real estate sector also remains under significant pressure.
“We’re still emerging from the COVID era, and a lot of the consumer financial health can be traced back to the stimulus provided during that time,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, potential issues for banks could manifest in the upcoming months. “The provisions you see in any given quarter do not necessarily reflect credit quality from the past three months; rather, they indicate what banks anticipate will happen in the future,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
“In a shift from historical trends, we see that macroeconomic forecasts are now driving provisions, rather than merely the performance of loans,” he added.
In the short term, banks are anticipating slowing economic growth, higher unemployment rates, and two interest rate cuts expected later in the year, which could lead to more delinquencies and defaults as the year comes to a close.
Citigroup’s CFO, Mark Mason, highlighted that the warning signs are particularly prevalent among lower-income consumers, whose savings have diminished since the pandemic began. “While the overall U.S. consumer appears resilient, there’s a noticeable divide in performance based on income levels,” Mason reported during a recent analyst call.
“Among our consumer clients, only those in the highest income quartile have maintained more savings compared to early 2019. It’s primarily those with over a 740 FICO score who are contributing to spending growth and keeping high payment rates,” he noted, adding that lower FICO score customers are experiencing a greater decrease in payment rates and borrowing more due to the intense impacts of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a two-decade high of 5.25-5.5%, holding off on cuts until inflation trends stabilize toward the Fed’s 2% target.
Despite the banks preparing for a potential increase in defaults in the latter half of the year, current default rates do not indicate a consumer crisis, according to Mulberry. He is particularly monitoring the distinctions between homeowners and renters during the pandemic.
“While interest rates have surged, homeowners secured very low fixed rates on their debt, so they are not feeling as much pressure. In contrast, renters missed that opportunity,” Mulberry remarked.
With rents rising over 30% nationwide from 2019 to 2023 and grocery costs increasing by 25% in that same timeframe, renters without locked-in low rates are facing significant financial strain, as noted by Mulberry.
Overall, the latest earnings reports suggest that the banking sector remains stable. “There was nothing particularly alarming this quarter regarding asset quality,” said Narron. Strong revenues, profits, and resilient net interest income point to a healthy banking environment.
“There’s a certain resilience in the banking sector that may not have been anticipated, but it’s reassuring to see that the financial system’s framework remains robust,” added Mulberry. “Nonetheless, the longer interest rates remain elevated, the greater the stress it may cause.”