With interest rates reaching their highest levels in over twenty years and inflation continuing to impact consumers, major banks are gearing up for potential risks associated with their lending operations.
In the second quarter of the year, 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 that banks allocate to cover anticipated losses from credit risks, including overdue debts and lending practices, particularly in commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America reported $1.5 billion. Citigroup’s allowance for credit losses rose to $21.8 billion by the end of the quarter, marking more than a threefold increase from the prior quarter. Additionally, Wells Fargo allocated $1.24 billion for provisions.
This increase in reserves indicates that banks are preparing for a more uncertain economic climate, where both secured and unsecured loans may present greater risks for these financial institutions. A New York Fed analysis revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
As pandemic-related savings diminish, credit card issuance and delinquency rates are also on the rise. Credit card debt totaled $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total balances surpassed the trillion-dollar milestone, according to TransUnion. The commercial real estate sector remains particularly vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector is still recovering from the effects of COVID-19 and its associated stimulus measures. However, potential issues for banks could arise in the coming months.
Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that current provisions do not solely reflect recent credit quality but are based on banks’ forecasts for the future. He highlighted a shift from a traditional system where increased loan defaults prompted higher provisions to one driven by macroeconomic predictions.
Looking ahead, banks anticipate a slowdown in economic growth, rising unemployment, and two potential interest rate cuts later this year in September and December, which could lead to an increase in delinquencies and defaults by year’s end.
Citi CFO Mark Mason observed that the warning signs are particularly evident among lower-income consumers, who have seen their savings decline since the pandemic. While the overall U.S. consumer appears resilient, differences persist across income and credit score groups.
Mason noted that only the highest-income quartile has managed to retain more savings compared to early 2019, with those boasting scores above 740 leading spending growth and maintaining high payment rates. Conversely, borrowers with lower FICO scores are showing erosion in payment rates and increased borrowing due to the burden of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% while awaiting inflation metrics to stabilize around its 2% target before implementing anticipated rate cuts.
Despite preparations for potential defaults later this year, current default rates do not indicate a consumer crisis, according to Mulberry. He is currently analyzing the differences between pandemic-era homeowners and renters, noting that homeowners locked in low fixed rates and are not feeling the same financial strain as renters who missed that opportunity.
Between 2019 and 2023, rents have surged over 30% nationally, while grocery costs have risen by 25%. Renters who did not secure low rates are experiencing the greatest financial pressure.
Overall, the most significant takeaway from the recent earnings reports is that “there was nothing new this quarter in terms of asset quality,” according to Narron. Strong revenue and profit figures, alongside healthy net interest income, suggest a robust banking sector.
Mulberry emphasized that although the banking industry’s structure remains strong and sound, ongoing high interest rates could lead to increased stress in the future.