As interest rates reach levels not seen in over two decades and inflation continues to pressure consumers, major banks are gearing up for increased risks linked to their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all boosted their provisions for credit losses compared to the previous quarter. These provisions represent funds that banks set aside to cover potential losses from credit risks, including delinquent loans and risky lending practices such as commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America increased its reserves to $1.5 billion. Citigroup reported a credit loss allowance of $21.8 billion at the end of the quarter, significantly more than in the previous period. Wells Fargo’s provisions stood at $1.24 billion.
The increase in these reserves indicates that banks are preparing for a more challenging financial environment, where both secured and unsecured loans may lead to higher losses for these financial institutions. A recent analysis by the New York Fed highlighted that Americans accumulate a total of $17.7 trillion in debt across consumer loans, student loans, and mortgages.
Additionally, there has been a rise in credit card issuance and delinquency rates as individuals deplete their pandemic-related savings and increasingly depend on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter with totals surpassing one trillion dollars, according to TransUnion. The commercial real estate sector also remains in a fragile state.
“We are still navigating the post-COVID landscape, especially in banking and consumer health, largely influenced by the stimulus provided to consumers,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Future challenges for banks might be on the horizon. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, pointed out that the provisions reported by banks do not necessarily reflect credit quality over the past three months but rather their expectations for the future.
He noted a shift from a time when increases in bad loans would trigger higher provisions, to a system more driven by macroeconomic forecasts.
In the short term, banks foresee a slowdown in economic growth, a rise in unemployment, and expected interest rate cuts later this year. This environment could lead to more delinquencies and defaults as the year progresses.
Citi’s chief financial officer, Mark Mason, highlighted that warning signs are particularly evident among lower-income consumers whose savings have diminished since the pandemic.
“While the overall U.S. consumer appears resilient, there is a noticeable disparity in performance and behavior across income and credit score categories,” Mason stated. “Only the highest income quartile has increased their savings since early 2019, with top-tier FICO score customers driving spending growth and maintaining consistent payment rates. Conversely, those in lower FICO brackets are experiencing declines in payment rates and are borrowing more due to being more affected by high inflation and interest rates.”
The Federal Reserve continues to maintain interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation metrics towards the central bank’s 2% target before implementing anticipated rate cuts.
Despite banks preparing for potential defaults in the coming months, current rates of defaults do not suggest an imminent consumer crisis, according to Mulberry. He is particularly monitoring the divide between homeowners and renters who experienced differing financial conditions during the pandemic.
Homeowners, who secured low fixed rates on their mortgages during that time, do not seem to be feeling the pressure as much, while renters are facing challenges due to a significant rise in rents, which have increased by over 30% nationwide from 2019 to 2023, along with grocery prices climbing 25% in the same timeframe.
Currently, the main takeaway from the recent batch of earnings is that there have been no major changes in asset quality. Strong revenues and profits, along with stable net interest income, are reassuring indicators of a strong banking sector.
“There remains strength in the banking sector, which is somewhat reassuring as it indicates the financial system is still robust,” Mulberry concluded. “However, we remain vigilant, as prolonged high interest rates will inevitably create more strain.”