With interest rates at their highest level in over two decades and inflation exerting pressure on consumers, major banks are bracing for increased risks associated with their lending practices.
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 reflect the funds that banks allocate to mitigate potential losses due to credit risks, such as delinquent accounts or bad debts, including commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America claimed $1.5 billion. Citigroup’s allowance for credit losses rose to $21.8 billion by the end of the quarter, more than tripling from the previous quarter’s reserve. Wells Fargo reported provisions of $1.24 billion.
These provisions indicate that banks are preparing for a more challenging environment where both secured and unsecured loans may lead to greater losses. A recent report from the New York Federal Reserve highlighted that American households are carrying a total debt of $17.7 trillion across consumer loans, student loans, and mortgages.
Growing credit card issuance and delinquency rates signal that consumers are depleting their pandemic-era savings and increasingly relying on credit. As reported by TransUnion, credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total balances surpassed this threshold. The commercial real estate sector also remains vulnerable.
“Coming out of the COVID period, the health of the consumer largely relied on the stimulus provided during that time,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Challenges for banks are expected to arise in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that bank provisions reflect future expectations rather than just recent credit quality.
He added, “Historically, when loans began to default, provisions would increase. Now, it’s largely driven by macroeconomic forecasts.”
In the near future, banks are anticipating slower economic growth, a rise in unemployment, and plans for two interest rate cuts later this year, which may lead to increased delinquencies and defaults.
Mark Mason, Chief Financial Officer of Citigroup, noted that these concerning trends are particularly evident among lower-income consumers who have seen their savings diminish since the pandemic.
“While the overall U.S. consumer remains resilient, there’s a noticeable divergence in performance based on income and credit scores,” Mason explained. “Only the top income quartile has managed to increase their savings since early 2019. Those with higher credit scores are driving spending growth, while lower credit score customers are borrowing more and experiencing payment difficulties due to high inflation and interest rates.”
The Federal Reserve is maintaining interest rates at a 23-year high of 5.25% to 5.5%, awaiting stabilization in inflation measures toward its 2% target before considering rate cuts.
Despite banks preparing for potential defaults in the latter half of the year, experts suggest that current default rates do not indicate an imminent consumer crisis. Mulberry is particularly attentive to differences between homeowners and renters from the pandemic period.
“While interest rates have significantly increased, homeowners secured low fixed rates and are largely insulated from immediate impacts,” Mulberry said. “Renters, however, have faced over a 30% hike in rents since 2019, alongside a 25% increase in grocery costs, leading to greater financial strain for them.”
For now, the main takeaway from recent earnings reports is that there are no alarming new developments regarding asset quality. Strong revenues, profits, and robust net interest income indicate that the banking sector remains in good health.
“There’s strength in the banking sector that is reassuring. The financial system appears strong and sound at this time,” Mulberry concluded. “However, we must remain vigilant as sustained high-interest rates may lead to greater stress.”