As interest rates remain at their highest in over 20 years and inflation continues to pressure 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 increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside by financial institutions to manage potential losses from credit risks, including delinquent debts and various lending types, such as 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 reserves surged to $21.8 billion by the end of the quarter, marking a more than threefold increase from the prior quarter. Wells Fargo reported provisions amounting to $1.24 billion.
These provisions indicate that banks are preparing for a riskier lending environment, where both secured and unsecured loans may lead to larger losses for some of the largest financial institutions in the country. A recent report from the New York Federal Reserve revealed that total household debt in the U.S. has reached $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
As pandemic-era savings diminish, credit card usage and delinquency rates are on the rise. Total credit card balances hit $1.02 trillion in the first quarter, continuing a trend of exceeding the trillion-dollar mark for the second consecutive quarter, according to TransUnion. Additionally, the commercial real estate sector remains in a fragile state.
“We’re still navigating the aftermath of the COVID era, particularly concerning banking and consumer health, which was significantly influenced by the stimulus provided to consumers,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, the challenges for banks are anticipated in the coming months. “The provisions reported in any given quarter do not solely reflect credit quality from the past three months; rather, they indicate what banks expect for the future,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He further noted a shift from a historical system where delinquent loans would drive provisions upward, to one where macroeconomic forecasts significantly influence provisioning decisions.
Looking ahead, banks are predicting a slowdown in economic growth, an increase in unemployment rates, and potential interest rate cuts later in the year, which could contribute to a rise in delinquencies and defaults.
Citi’s chief financial officer, Mark Mason, pointed out that concerning trends appear primarily among lower-income consumers, who have experienced declines in their savings over the years since the pandemic.
“While the overall U.S. consumer remains resilient, we’re observing a divergence in performance across different income brackets and credit scores,” Mason stated. “Only the highest income quartile has more savings now compared to early 2019, and it is primarily the customers with FICO scores over 740 who are driving spending growth and maintaining high payment rates. In contrast, lower FICO band customers are facing significant challenges.”
The Federal Reserve has kept interest rates between 5.25% and 5.5%, their highest level in 23 years, as it awaits signs of a stabilizing inflation rate at the central bank’s target of 2% before implementing any anticipated rate cuts.
Despite banks preparing for increased defaults in the latter part of the year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He is particularly attentive to the contrast between homeowners and renters since the pandemic began.
“While interest rates have risen significantly, homeowners who secured low fixed rates on their debts are less impacted,” Mulberry noted. “Renters, on the other hand, did not have that opportunity and are facing higher rent expenses.”
Between 2019 and 2023, rent prices surged over 30% nationally, and grocery costs increased by 25%, placing significant financial strain on renters who have not seen their wages grow at the same rate.
For the time being, the latest earnings reports reflect that “there’s nothing new concerning asset quality,” according to Narron. Strong revenues, profits, and resilient net interest income are indicative of a still-robust banking sector.
“There is some strength in the banking system that might not have been entirely unexpected, but it is certainly reassuring to know that the financial system’s structures remain solid at this moment,” Mulberry remarked. “However, we remain vigilant as prolonged high interest rates could lead to increased stress.”