With interest rates reaching levels not seen in over 20 years and inflation posing challenges for consumers, major banks are bracing for increased risks associated with their lending activities.
In the second quarter of this year, 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 banks reserve to offset potential losses from credit risks, including defaults on loans and commercial real estate (CRE) lending.
JPMorgan set aside $3.05 billion for credit losses, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses surged to $21.8 billion, reflecting a more than threefold increase from the prior quarter. Wells Fargo reported provisions of $1.24 billion.
The increase in reserves indicates that banks are preparing for a potentially riskier environment, as both secured and unsecured loans may lead to larger losses among the country’s largest financial institutions. A recent study by the New York Fed revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates have also been rising, as many consumers deplete their pandemic-era savings and increasingly rely on credit. In the first quarter alone, credit card balances reached $1.02 trillion, marking the second consecutive quarter where total cardholder debt exceeded the trillion-dollar threshold. Additionally, commercial real estate remains under pressure.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector is still adjusting to the aftermath of the COVID era, particularly regarding consumer health influenced by government stimulus measures.
Problems for banks, however, may arise in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, stated that the provisions noted in any quarter do not solely reflect recent credit quality; instead, they anticipate future developments.
The banks expect a slowdown in economic growth, an increase in unemployment rates, and two anticipated interest rate reductions later this year, which could lead to more delinquencies and defaults as the year progresses.
Citi’s chief financial officer, Mark Mason, indicated that the warning signs seem particularly concentrated among lower-income consumers, who have seen their savings decrease since the pandemic.
“While we continue to see an overall resilient U.S. consumer, we also observe a divergence in performance and behavior across FICO and income levels,” Mason remarked in a recent analyst call. He noted that only the highest income quartile has more savings than at the beginning of 2019, and customers with FICO scores over 740 are contributing to spending growth while maintaining high payment rates. Conversely, lower FICO score customers are experiencing significant drops in payment rates and are increasingly borrowing due to the impact of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a historical high of 5.25-5.5% as it seeks to stabilize inflation toward its 2% target before implementing much-anticipated rate cuts.
Despite the banks’ preparations for increased defaults in the latter half of the year, Mulberry pointed out that defaults are not currently rising at a pace indicative of a consumer crisis. He is particularly focused on the contrast between homeowners who benefited from low fixed rates during the pandemic and renters who missed out on those advantages.
Although interest rates have surged, many homeowners are insulated from financial pressure because of their low fixed rates. In contrast, renters face escalating costs, with rents rising over 30% nationwide between 2019 and 2023, and grocery prices increasing by 25% in the same period. Renters without locked-in low rates are now stressed by rising rental prices outpacing wage growth.
For the time being, the latest earnings reports suggest that “there was nothing new this quarter in terms of asset quality,” according to Narron. The banking sector continues to display robust revenues, profits, and resilient net interest income, indicating a generally healthy state.
“There’s a strength in the banking sector that may not have been entirely unexpected, but it certainly is reassuring to say that the financial system remains strong and sound at this point,” Mulberry commented. “However, closer monitoring is necessary because prolonged high interest rates could induce additional stress.”