With interest rates at their highest levels in over two decades and inflation pressing down on 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 increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside by financial institutions to cover potential losses from credit risks, including bad debts and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s allowance totaled $21.8 billion, more than tripling its previous quarter’s reserve; and Wells Fargo’s provisions amounted to $1.24 billion.
These increasing reserves indicate that banks are preparing for a riskier environment, where both secured and unsecured loans may lead to greater losses for some of the nation’s largest financial institutions. A recent analysis from the New York Fed revealed that total household debt has surged to $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
The issuance of credit cards and the rates of delinquency are both on the rise as consumers exhaust their pandemic-era savings and rely more heavily on credit. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that overall cardholder balances surpassed the trillion-dollar threshold. Additionally, the commercial real estate sector continues to encounter significant challenges.
“We’re still emerging from the COVID era, and particularly in reference to banking and consumer health, much of it was dependent on the stimulus directed toward consumers,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any issues facing banks are anticipated to manifest in the coming months.
“The provisions reported for any given quarter don’t necessarily reflect the credit quality of the past three months; they indicate banks’ expectations about future developments,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
“It’s interesting to note that we have shifted from a system where increased loan defaults would raise provisions to one where macroeconomic forecasts primarily drive provisioning,” he added.
In the short term, banks are forecasting slowed economic growth, rising unemployment, and potential interest rate cuts in September and December, which could lead to higher rates of delinquency and default as the year concludes.
Citi’s Chief Financial Officer Mark Mason highlighted that these warning signs are especially apparent among lower-income consumers, who have seen their savings diminish in recent years.
“While we continue to see an overall resilient U.S. consumer, we also notice differences in performance and behavior among income levels and credit scores,” Mason stated during a recent analyst call.
“Only consumers in the highest income quartile have more savings than they did in early 2019, and it is those with FICO scores above 740 who are driving spending growth and maintaining higher payment rates,” he noted. “Customers in lower FICO brackets are experiencing sharper declines in payment rates and are borrowing more, facing greater challenges due to high inflation and rising interest rates.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting inflation metrics to stabilize around the central bank’s target of 2% before implementing the expected rate cuts.
Despite preparations for more widespread defaults later in the year, experts indicate that defaults are not currently rising at a rate indicative of a consumer crisis. Mulberry stressed the importance of distinguishing between homeowners and renters during this period.
“Yes, rates have increased significantly, but homeowners secured very low fixed rates on their debt, so they’re largely insulated from the pain,” Mulberry remarked. “Renters, however, who missed that opportunity are facing significant challenges.”
Nationwide, rents have surged more than 30% from 2019 to 2023, while grocery costs have risen by 25%, adding financial strain for renters who have not been able to lock in lower rates, as noted by Mulberry.
For the moment, the major takeaway from the latest earnings reports is that “there was nothing new this quarter concerning asset quality,” Narron mentioned. In fact, robust revenues, profits, and stable net interest income are encouraging signs of a healthy banking sector.
“There’s some resilience in the banking sector that may not have been entirely expected, but it’s comforting to see that the financial system remains strong and sound at this juncture,” Mulberry concluded. “Nonetheless, we are monitoring the situation closely; the longer interest rates remain high, the more pressure they exert.”