As interest rates reach levels not seen in over 20 years and inflation continues to impact consumers, major banks are bracing for increased risks tied to their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all reported increases in their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks set aside to protect against potential credit losses, including delinquent debts and lending activities such as commercial real estate (CRE) 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 surged to $21.8 billion by the end of the quarter, more than tripling its reserve build from the prior quarter. Wells Fargo’s provisions stood at $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier economic landscape, where both secured and unsecured loans may lead to larger losses for some of the largest banking institutions. A recent analysis from the New York Federal Reserve revealed that Americans hold a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as individuals deplete their pandemic-era savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter in which balances exceeded the trillion-dollar threshold, according to TransUnion. Additionally, the position of CRE remains uncertain.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted, “We are still emerging from the COVID era, particularly concerning banking and consumer health. The support provided to consumers through stimulus funding has played a significant role.”
However, the true challenges for banks lie ahead. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, explained, “The provisions reported by banks do not directly reflect credit quality from the past three months but rather their expectations for the future.”
He added that the industry has transitioned to a situation where macroeconomic forecasts dictate provisioning levels rather than a traditional model where rising defaults lead to increased provisions.
In the short term, banks anticipate slower economic growth, a rise in unemployment, and potential interest rate cuts later this year. This could lead to heightened delinquency and default rates as the year draws to a close.
Citi’s Chief Financial Officer Mark Mason highlighted that these warning signs are particularly evident among lower-income consumers, who have seen their savings diminish since the pandemic began. He remarked, “While we still observe an overall resilient U.S. consumer market, we also see a divergence in performance across different income levels and credit scores.”
Mason stated that only the highest-income quartile has managed to retain more savings compared to early 2019, with spending growth and high payment rates primarily driven by consumers with FICO scores above 740. In contrast, those in lower credit score brackets are experiencing significant declines in payment rates and are borrowing more due to the acute impact of rising inflation and interest rates.
The Federal Reserve maintains interest rates at a 23-year high of 5.25-5.5%, monitoring inflation metrics in hopes of stabilizing towards its 2% target before implementing anticipated rate cuts.
Despite banks bracing for potential defaults later in the year, Mulberry pointed out that current default rates do not signal a consumer crisis. He suggested monitoring the experiences of homeowners versus renters during the pandemic. Homeowners, who secured low fixed rates, are generally less affected by rising rates compared to renters facing surging rents.
According to Mulberry, rents have increased by over 30% nationally from 2019 to 2023, while grocery prices have risen 25%. Renters, not having the opportunity to lock in low rates, are experiencing greater financial strain.
Overall, the most recent earnings reports indicated that “there was nothing new this quarter in terms of asset quality,” as stated by Narron. Strong gains in revenue, profits, and net interest income are encouraging signs of a robust banking sector.
Mulberry concluded, “There is strength in the banking sector, which is reassuring given the current landscape. However, we continue to monitor the situation closely, as prolonged high interest rates will add more stress.”