As interest rates remain at their highest levels in over twenty years and inflation continues to impact consumers, major banks are preparing for increased risks associated with their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all elevated their credit loss provisions compared to the previous quarter. These provisions indicate the funds these banks set aside to cover potential losses from credit risks such as delinquent debts and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s allowance reached $21.8 billion, more than tripling its reserves from the prior quarter; and Wells Fargo provided $1.24 billion.
This increase in provisions suggests that banks are bracing for a more challenging environment, where both secured and unsecured loans could result in larger losses. A recent analysis from the New York Fed found that total household debt in the US amounts to $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
The issuance of credit cards and the subsequent rise in delinquency rates are also climbing as many draw down their pandemic-related savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter, marking the second straight quarter where balances surpassed the trillion-dollar threshold, according to TransUnion. Commercial real estate remains particularly vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector is still adjusting in the aftermath of COVID-19, which was heavily influenced by stimulus measures aimed at consumers.
Looking forward, any difficulties for banks are expected to manifest in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that the provisions banks report may not accurately reflect recent credit quality but rather anticipate future developments.
Narron indicated that banks currently foresee slowing economic growth, rising unemployment, and two anticipated interest rate cuts later this year, which could lead to increased delinquencies and defaults.
Citi’s CFO Mark Mason highlighted that risks are particularly pronounced among lower-income consumers who have seen their savings significantly decline since the pandemic. He remarked on the disparity in financial health among consumers, noting that only the highest income quartile has maintained higher savings compared to early 2019.
Mason pointed out that consumers with FICO scores above 740 are responsible for driving spending growth and sustaining high payment rates. In contrast, those in lower FICO brackets experience a notable decrease in payment rates and are borrowing more as they cope with the effects of high inflation and interest rates.
The Federal Reserve currently maintains interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation figures to move toward planned rate cuts.
Despite banks’ preparations for potential defaults later this year, Mulberry observed that defaults have not yet increased significantly enough to signal a broader consumer crisis. He noted a distinction between the circumstances of homeowners and renters during this period of rising interest rates.
Homeowners locked in low fixed rates, thus largely avoiding financial strain, whereas renters—who did not benefit from such rates—are facing pressure from increased rental prices and rising grocery costs over the past few years.
Overall, the latest earnings reports indicated a stabilizing banking sector, with robust revenues and profits offering positive insights into asset quality. Narron remarked that there were no significant changes in asset quality in the recent quarter, and Mulberry expressed relief regarding the strength of the financial system, although cautioning that sustained high interest rates could cause future stress.