With interest rates reaching levels not seen in over 20 years and inflation still affecting consumers, major banks are preparing for increased risks associated with their lending operations.
During 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 that banks set aside to cover potential losses from credit risks, such as bad debts and delinquent loans, including those in commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses rose to $21.8 billion at the end of the quarter, more than tripling its reserve compared to the prior quarter, and Wells Fargo’s provisions stood at $1.24 billion.
These provisions indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans may incur larger losses. Recent analysis from the New York Federal Reserve revealed that U.S. consumers collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as people deplete their savings from the pandemic and increasingly rely on credit. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where the total surpassed the trillion-dollar mark. Meanwhile, the commercial real estate sector remains vulnerable.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking sector is still adjusting post-COVID, particularly in relation to consumer health influenced by government stimulus programs.
Issues for banks may surface in the upcoming months. Mark Narron, a senior director at Fitch Ratings, noted that the provisions reported each quarter reflect banks’ expectations for future credit conditions rather than past credit quality.
He explained that the focus has shifted from a traditional model where rising loan defaults trigger higher provisions, to one where macroeconomic predictions significantly influence provisioning decisions.
Currently, banks foresee weaker economic growth, a higher unemployment rate, and several expected interest rate cuts later this year. These factors could contribute to increased delinquencies and defaults as the year progresses.
Citigroup’s CFO Mark Mason pointed out that warning signs are particularly pronounced among lower-income consumers who have seen their savings diminish since the pandemic.
While the broader U.S. consumer remains resilient, there are marked differences in performance based on income and credit scores. Mason noted that only the highest income quartile has greater savings than at the start of 2019, and consumers with high credit scores are leading spending and payment consistency. Conversely, those with lower credit scores are experiencing a decline in payment rates while borrowing more, facing significant challenges from high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high range of 5.25% to 5.5% as it monitors inflation toward its 2% target before considering rate cuts.
Despite banks bracing for potential higher defaults, current default rates do not indicate a looming consumer crisis, according to Mulberry. He highlighted the distinction between homeowners and renters, noting that homeowners benefited from locking in low fixed mortgage rates during the pandemic and are less affected by rising rates. In contrast, renters, who have seen rents rise over 30% since 2019 while wage growth has not kept pace, are feeling more financial strain.
While there are challenges ahead, the latest earnings reports suggest that asset quality remains stable, with strong revenues, profits, and resilient net interest income indicating a healthy banking environment. Mulberry remarked on the ongoing strength of the banking sector and expressed reassurance about the resilience of the financial system, while also emphasizing the need for vigilance as high interest rates persist.