As interest rates reach their highest level in over two decades and inflation continues to impact consumers, major banks are gearing up to confront increased risks related to their lending activities.
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 represent funds that banks set aside to manage potential losses from credit risks, including bad debts and loans, notably in commercial real estate.
Specifically, JPMorgan allocated $3.05 billion for credit losses, 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, more than tripling its reserves from the previous quarter. Wells Fargo recorded provisions of $1.24 billion.
These increases indicate that banks are preparing for a more challenging environment, anticipating greater losses from both secured and unsecured loans. A recent analysis by the New York Federal Reserve revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance is rising, and delinquency rates are also trending upward, as consumers exhaust their pandemic-era savings. Credit card balances exceeded $1 trillion for the second consecutive quarter, according to TransUnion. The state of commercial real estate also remains uncertain.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the ongoing recovery from the COVID-19 pandemic and the previous stimulus provided to consumers.
However, potential issues for banks may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions banks report do not always reflect recent credit quality but rather expectations for the future.
“We’ve shifted from a system where increases in bad loans triggered higher provisions to one where macroeconomic forecasts primarily dictate provisioning,” he noted.
In the short term, banks anticipate a slowdown in economic growth, a rising unemployment rate, and two interest rate cuts expected later this year in September and December. These factors could lead to increased delinquencies and defaults as the year concludes.
Citigroup’s Chief Financial Officer Mark Mason indicated that concerns appear to be concentrated among lower-income consumers, who have seen their savings diminish since the pandemic.
“While the overall U.S. consumer remains resilient, we see varying performance across income and credit score bands,” Mason stated in a recent call with analysts. He noted that only the highest income quartile has increased their savings since 2019, with customers boasting over a 740 FICO score driving spending growth. In contrast, those in lower FICO score ranges are experiencing declines in payment rates and are borrowing more, heavily affected by high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% while awaiting stabilization in inflation measures towards the central bank’s 2% target before implementing anticipated rate cuts.
Despite banks preparing for potential defaults later this year, current default rates are not yet indicative of a consumer crisis, according to Mulberry. He is closely observing the distinction between homeowners and renters.
“Although rates have risen significantly, homeowners secured low fixed rates, so they are not feeling the financial strain as acutely,” he noted. “In contrast, renters, who missed this opportunity, face substantial increases in rent.”
Since 2019, national rents have surged over 30%, while grocery costs have risen 25%, putting additional pressure on renters who are struggling with wage growth that hasn’t kept pace with rising living costs.
Overall, the latest earnings reports suggest stability in asset quality, with solid revenues, profits, and healthy net interest income reflecting a robust banking sector. Narron remarked that there were no significant changes in asset quality this quarter, highlighting ongoing strength in the financial system.
“There’s some strength in the banking sector that was not entirely unexpected, and it’s reassuring to see that the foundations of the financial system remain sound,” Mulberry emphasized. However, he cautioned that prolonged high interest rates could lead to increasing stress in the future.