With interest rates at their highest level in over 20 years and persistent inflation impacting consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, leading banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions represent funds set aside by financial institutions to cover potential losses from credit risks, which may include delinquent debts and lending activities like commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses during the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses amounted to $21.8 billion by the end of the quarter, significantly enhancing its reserves from the previous quarter, and Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging environment, anticipating that defaults on both secured and unsecured loans could impact some of the nation’s largest financial institutions. According to a recent analysis by the New York Fed, American households collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Furthermore, credit card issuance and delinquency rates are rising as consumers deplete their savings accumulated during the pandemic and increasingly rely on credit. In the first quarter of this year, total credit card balances hit $1.02 trillion, marking the second consecutive quarter that the aggregate exceeded this threshold, as per TransUnion data. The commercial real estate sector also faces ongoing challenges.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted that the banking sector is still emerging from the COVID-19 era, largely due to the economic stimulus that was provided to consumers. However, potential banking issues lie ahead.
“The provisions reported in any given quarter do not necessarily reflect credit quality over the last three months; they reflect banks’ expectations for future developments,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He added that the current shift shows a transition from a system where rising loan defaults would lead to increased provisions to one where macroeconomic forecasts heavily influence provisioning decisions.
In the short term, banks anticipate a slowdown in economic growth, a rise in unemployment, and two expected interest rate cuts later this year, which could lead to higher rates of delinquencies and defaults by year-end.
Citi’s CFO Mark Mason highlighted that these concerning trends are primarily evident among lower-income consumers, who have seen their savings diminish since the pandemic began.
“Although we’re seeing overall resilience in the U.S. consumer, performance varies significantly across different income levels and credit scores,” Mason stated during an analyst call. He pointed out that only the upper income quartile has more savings than they did at the start of 2019. Meanwhile, customers with higher credit scores are driving spending growth and maintaining timely payments, while those with lower credit scores are experiencing declines in payment rates and increased borrowing, largely due to the impacts of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high, between 5.25% and 5.5%, as it monitors inflation trends in hopes of achieving a long-term target of 2% before implementing expected rate cuts.
While banks are gearing up for a possible rise in defaults later in the year, current data does not indicate an imminent consumer crisis, according to Mulberry. He is particularly interested in comparing the situations of homeowners and renters during this period.
“Although interest rates have risen significantly, homeowners secured very low fixed rates on their debt, so they are not feeling the impact as acutely,” Mulberry noted. In contrast, renters, who lacked this opportunity, face significant financial pressure as rents have surged more than 30% since 2019, coupled with a 25% increase in grocery prices over the same timeframe.
Despite these concerns, the latest earnings reports indicate that there are no alarming changes regarding asset quality. Strengthened revenues, profits, and stable net interest income remain positive signs for a healthy banking sector.
“There’s some resilience in the banking industry that may not have been entirely expected, but it’s certainly reassuring to see that the foundations of the financial system are still robust,” Mulberry concluded. “However, we must remain vigilant; the sustained high levels of interest rates could introduce more strain.”