With interest rates reaching levels not seen in over 20 years and inflation continuing to pressure consumers, major banks are preparing to navigate 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 represent funds that financial institutions set aside to cover potential losses from credit risks, which include overdue or defaulted loans and delinquencies in sectors like commercial real estate.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter, while Bank of America set aside $1.5 billion. Citi’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 placed provisions at $1.24 billion.
These increased reserves signal that banks are bracing for a more challenging environment, where both secured and unsecured loans could lead to greater losses. A recent analysis from the New York Federal Reserve indicated that total household debt in the U.S. now stands at $17.7 trillion, covering consumer loans, student loans, and mortgages.
The rise in credit card issuance and accompanying delinquency rates suggests that as consumers deplete their pandemic-era savings, they are increasingly relying on credit. Total credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where overall balances surpassed the trillion-dollar threshold. The commercial real estate sector also remains in a precarious situation.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking sector is still navigating the aftermath of the pandemic, particularly concerning consumer health and the impact of government stimulus aimed at consumers.
However, challenges for banks could emerge in the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, noted that the provisions reported by banks reflect their expectations for future conditions, rather than just recent credit quality. He explained that the focus has shifted from a traditional model, where increased loan defaults would prompt higher provisions, to a system driven by macroeconomic forecasts.
Looking ahead, banks anticipate slower economic growth, a rise in unemployment, and potential interest rate cuts later this year, which could lead to increased delinquencies and loan defaults as the year concludes.
Citigroup’s chief financial officer, Mark Mason, highlighted concerns particularly affecting lower-income consumers, who have seen their savings diminish since the pandemic began. He pointed out that while the overall U.S. consumer remains resilient, there is a notable divergence based on income levels and credit scores. Higher-income consumers have generally managed to increase their savings since early 2019, while those with lower credit scores are experiencing decreased payment rates and increased borrowing.
The Federal Reserve maintains interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation to meet its 2% target before implementing anticipated rate cuts.
Despite banks preparing for potential default increases, current default rates are not yet indicating a consumer crisis, according to Mulberry. He noted a significant distinction between the experiences of homeowners and renters during the pandemic. Homeowners, who locked in low fixed rates, are less affected by rising rates, while renters, who missed that opportunity, face increasing financial strain.
Mulberry pointed out that rents have surged over 30% nationwide from 2019 to 2023, along with a 25% rise in grocery costs, which has led to budgeting challenges for renters, particularly as rent increases outpace wage growth.
For now, the latest earnings reports suggest no significant changes in asset quality for the banks. Strong revenues, profits, and resilient net interest income indicate a healthy banking sector amid prevailing challenges. Mulberry remarked that while some strength in the banking sector was anticipated, it is reassuring to witness the robustness of the financial system. Nonetheless, ongoing monitoring is crucial as prolonged high interest rates could increase financial stress.