With interest rates at a peak not seen in over two decades and inflation impacting consumers heavily, major banks are bracing for increased risks in 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 the funds that banks reserve to cover potential losses from credit risks, such as overdue debts and problematic loans, including those for commercial real estate.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, marking more than a threefold increase from the previous quarter, and Wells Fargo recorded $1.24 billion in provisions.
These increased provisions indicate that banks are preparing for a more challenging economic environment, where the risks associated with both secured and unsecured loans could lead to larger losses. According to a recent analysis by the New York Fed, Americans collectively owe about $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the upsurge, as many individuals deplete their savings from the pandemic and depend more on credit. In the first quarter of this year, total credit card balances hit $1.02 trillion, marking the second consecutive quarter in which cardholder balances surpassed the trillion-dollar threshold, as reported by TransUnion. Additionally, the commercial real estate sector faces uncertainties.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted, “We’re still coming out of this COVID era, especially regarding banking and consumer health, which was bolstered by stimulus measures.”
However, the challenges for banks are expected to intensify in the coming months.
Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained, “The provisions you see for any given quarter don’t only reflect credit quality for the past three months; they indicate what banks anticipate will happen in the future.”
He pointed out that the trend has shifted from a system where rising loan defaults prompted increased provisions to one where macroeconomic forecasts are driving provisioning decisions.
In the short term, banks are forecasting slower economic growth, a higher unemployment rate, and two anticipated interest rate cuts later this year in September and December. This scenario could lead to more delinquent payments and defaults before the year ends.
Citigroup’s chief financial officer, Mark Mason, remarked that the concerns are particularly pronounced among lower-income consumers, who have seen their savings diminish since the pandemic.
“While we observe an overall resilient U.S. consumer, there’s a noticeable divergence in performance and behavior across income levels and credit scores,” Mason said during an analyst call. “Among our consumer clients, only the highest income quartile has more savings now compared to early 2019, and it is the over-740 FICO score customers driving spending growth and maintaining high payment rates.”
The Federal Reserve has maintained interest rates at a 23-year high between 5.25% and 5.5%, awaiting inflation measures to stabilize towards its 2% target before implementing much-anticipated rate cuts.
Despite preparations for increased defaults in the latter half of the year, defaults are not escalating at a rate indicative of a consumer crisis, according to Mulberry. He is particularly watching the distinctions between individuals who owned homes during the pandemic and those who rented.
“While rates have risen significantly, homeowners secured low fixed rates on their debts and are not feeling the pinch,” Mulberry noted. “Renters missed out on that opportunity.”
Given that rents have surged by over 30% nationwide from 2019 to 2023 and grocery prices have climbed 25% in the same period, renters—who did not benefit from locked-in low rates—are under the most financial strain.
Currently, the key takeaway from this latest earnings cycle is that “there was nothing new this quarter regarding asset quality,” Narron stated. In fact, robust revenues, profits, and stable net interest income are encouraging indicators of a robust banking sector.
“There’s a resilience in the banking sector that wasn’t entirely unexpected, but it’s reassuring to see that the financial system’s fundamentals remain strong,” Mulberry remarked. “However, we are closely monitoring the situation, as prolonged high interest rates are likely to heighten stress.”