As interest rates reach levels not seen in over 20 years and inflation continues to pressure consumers, major banks are bracing for increased risks associated with their lending activities.
In the second quarter, prominent financial institutions 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 the funds set aside by banks to cover potential losses stemming from credit risk, including defaults on loans and debt such as commercial real estate (CRE) loans.
Specifically, JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s credit loss allowance reached $21.8 billion at the close of the quarter, marking a more than threefold increase from the last quarter. Wells Fargo designated $1.24 billion for this purpose.
These increased reserves indicate that banks are preparing for a challenging economic environment, where both secured and unsecured loans may lead to greater losses. Recent data from the New York Fed showed that U.S. consumers collectively owe $17.7 trillion in various types of loans, including consumer and student loans as well as mortgages.
There is also a rising trend in credit card issuance and delinquency rates as consumers deplete their pandemic savings and increasingly depend on credit. As of the first quarter of this year, credit card balances climbed to $1.02 trillion, marking the second consecutive quarter that total balances surpassed the trillion-dollar threshold, according to TransUnion. Additionally, the commercial real estate sector remains under significant pressure.
Experts note that the banking sector is still navigating the aftermath of the COVID-19 pandemic, particularly in terms of consumer health, which was bolstered by substantial government stimulus. However, potential banking challenges may arise in the coming months.
“The provisions you see in a given quarter don’t always reflect the credit quality from the previous three months; they are more indicative of what banks anticipate for the future,” explained Mark Narron, a senior director at Fitch Ratings.
Narron emphasized the shift from a traditional model, where rising loan defaults would trigger increased provisions, to a contemporary approach driven by macroeconomic forecasts.
In the near future, banks are anticipating slower economic growth, a higher unemployment rate, and two interest rate cuts expected for September and December. This may lead to increased delinquencies and defaults as the year concludes.
Citi’s CFO Mark Mason highlighted that the warning signs primarily emerge from lower-income consumers, whose financial cushions have diminished since the pandemic began. “While the overall U.S. consumer remains resilient, there is a noticeable disparity in performance across different income levels,” he noted.
Mason pointed out that only the top income quartile has more savings than it did at the end of 2019, with those holding a credit score above 740 mostly driving spending growth and maintaining stable payment habits. Conversely, consumers with lower credit scores are experiencing greater financial stress, evidenced by declining payment rates as they borrow more due to high inflation and rising interest rates.
The Federal Reserve maintains interest rates at a 23-year high of 5.25-5.5% while awaiting improvements in inflation towards its target of 2% before considering any significant rate reductions.
Despite preparations for potential defaults worsening in the latter half of the year, current data does not indicate a consumer crisis yet, according to Mulberry. He is particularly observing the divide between homeowners and renters during this economic period.
While interest rates have surged, homeowners have secured low fixed-rate mortgages, thus avoiding immediate financial strain, unlike renters facing steep increases in housing costs. With rents rising by over 30% nationwide and grocery prices climbing 25% from 2019 to 2023, those who were unable to secure stable rates are experiencing significant financial pressure.
Overall, the latest earnings reports reveal no alarming trends in asset quality within the banking sector. Strong revenues, profits, and resilient net interest income suggest that the banking system remains healthy. “The strength in the banking sector is somewhat reassuring, indicating that the financial system is still robust,” concluded Mulberry. “However, we remain vigilant as prolonged high-interest rates could escalate stress in the economy.”