With interest rates at their highest in over 20 years and inflation impacting consumers, major banks are gearing up for increased risks in their lending operations.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo have all upped their provisions for credit losses from the previous quarter. These provisions serve as a financial buffer to protect against potential losses stemming from credit risks, including bad debt and commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, representing a more than threefold increase from the prior quarter. Wells Fargo added $1.24 billion to its provisions.
These provisions highlight the banks’ preparation for a more uncertain lending environment, where both secured and unsecured loans could lead to greater losses. A recent analysis of household debt by the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
As pandemic-era savings dwindle, credit card issuance and delinquency rates are rising. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter with totals exceeding $1 trillion, according to TransUnion. Additionally, commercial real estate remains vulnerable.
“We’re still emerging from the COVID era, particularly regarding banking and consumer health, which was heavily influenced by the stimulus provided to consumers,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Challenges for banks might surface in the upcoming months. “Provisions reported in any given quarter do not solely reflect credit quality over the last three months; they indicate what banks anticipate will happen in the future,” stated Mark Narron, a senior director at Fitch Ratings.
He noted a shift from a system where provisions rose only when loans performed poorly, to one where macroeconomic forecasts are driving provisioning decisions. Banks are predicting slower economic growth, a rising unemployment rate, and possible interest rate cuts later this year, which could lead to more delinquencies and defaults as the year ends.
Citi’s chief financial officer, Mark Mason, highlighted concerning trends primarily among lower-income consumers, who have seen their savings decline since the pandemic. He remarked, “While we see resilience among U.S. consumers overall, there is a noticeable difference in performance across income levels and credit scores.”
Mason pointed out that only the highest income quartile has saved more now than in 2019, with those boasting over a 740 FICO score driving spending growth and maintaining high payment rates. In contrast, customers with lower FICO scores are experiencing a drop in payment rates and increased borrowing due to the impacts of high inflation and interest rates.
The Federal Reserve has maintained interest rates between 5.25% and 5.5%, the highest in 23 years, while awaiting a stabilization of inflation measures around its 2% target before enacting anticipated rate cuts.
Although banks are bracing for greater defaults later in the year, current defaults do not indicate a consumer crisis, according to Mulberry. He is particularly focused on the contrast between homeowners and renters from the pandemic period.
“While interest rates have risen significantly, homeowners locked in low fixed rates, so they’re not feeling the immediate impact as much as renters, who missed those opportunities,” Mulberry noted. Rent has increased over 30% nationwide from 2019 to 2023, and grocery prices have risen 25%, placing significant stress on renters whose incomes have not kept pace.
Currently, the overall performance of the banking sector appears stable, with “no new issues regarding asset quality,” according to Narron. Strong revenues, profits, and net interest income indicate a healthy banking environment.
“There are signs of strength within the banking sector, which is somewhat expected; however, it is reassuring to see that the financial system’s structures remain strong and sound,” Mulberry concluded. “Nonetheless, we are monitoring the situation closely, as prolonged high interest rates will increase stress.”