As interest rates remain at their highest levels in over two decades and inflation continues to impact 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 enhanced their provisions for credit losses compared to the previous quarter. These provisions represent the funds set aside by financial institutions to cover potential losses from credit risks, such as delinquent debts and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, a figure that more than tripled from the previous period; Wells Fargo’s provisions stood at $1.24 billion.
These increases indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans might lead to more significant losses. The New York Federal Reserve recently reported that Americans collectively owe $17.7 trillion in consumer, student, and mortgage loans.
Additionally, credit card issuances and delinquency rates are climbing as consumers are tapping into credit more frequently as their pandemic savings diminish. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that the total exceeded the trillion-dollar threshold. The commercial real estate sector also remains uncertain.
“We’re still emerging from the COVID period, especially in banking and consumer health, largely due to the stimulus allocated to consumers,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, challenges for banks may materialize in the coming months. “Provisions reported in any quarter do not necessarily mirror credit quality over the past three months; instead, they reflect banks’ expectations for the future,” noted Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
Narron added that historically, provision levels increased as loans began to default, but now, macroeconomic forecasts predominantly shape provisions. Currently, banks anticipate slower economic growth, a higher unemployment rate, and interest rate cuts later this year in September and December, which could result in more delinquencies and defaults by year’s end.
Mark Mason, chief financial officer of Citigroup, pointed out that red flags are mostly evident among lower-income consumers, who have seen their savings decline since the pandemic. “While the overall U.S. consumer remains resilient, we observe significant variations in performance across income and credit score bands,” Mason explained during a recent call with analysts.
He added, “Only the highest income quartile has increased its savings since early 2019. Those with FICO scores above 740 are leading the growth in spending and maintaining high payment rates. Conversely, customers with lower FICO scores are experiencing a drop in payment rates and borrowing more 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 metrics, aiming for the central bank’s target of 2% before enacting anticipated rate cuts.
Despite banks preparing for greater delinquency rates in the latter half of the year, they do not yet observe a surge in defaults indicating a consumer crisis, according to Mulberry. He is particularly focused on the distinction between homeowners and renters post-pandemic.
“Although interest rates have considerably increased, homeowners secured low fixed rates on their debts and are not feeling the pressure as acutely,” Mulberry noted. “This advantage has not extended to renters who missed the opportunity.”
With rents having spiked over 30% nationwide from 2019 to 2023, and grocery prices soaring 25% during the same time frame, those renting and unable to secure low rates are facing greater financial strain, as outlined by Mulberry.
For now, the latest earnings report suggests stability in asset quality. “Overall, there weren’t any new issues reported this quarter regarding asset quality,” said Narron. Strong revenues, profits, and robust net interest income indicate a resilient banking sector.
“There’s a level of strength within the banking sector that was perhaps not entirely unexpected, but it’s reassuring to recognize that the financial system’s structures are currently strong and sound,” Mulberry concluded. “However, we are monitoring the situation closely, as prolonged high-interest rates will inevitably cause more strain.”