With interest rates currently at their highest levels in over two decades and inflation continuing to impact consumers, major banks are preparing for potential risks associated with their lending practices.
In the second quarter, significant banks including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside by financial institutions to cover potential losses from credit risks, such as overdue debts and troubled loans, particularly in the commercial real estate sector.
JPMorgan allocated $3.05 billion for credit losses in the latest quarter, while Bank of America set aside $1.5 billion. Citigroup’s provisions reached $21.8 billion by the end of the quarter, more than tripling from the prior period. Wells Fargo’s provisions totaled $1.24 billion.
These increased reserves indicate that banks are anticipating a more hazardous lending environment, where both secured and unsecured loans may lead to greater losses. A recent New York Fed analysis revealed that total household debt in the U.S. has reached $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
Credit card issuance is also increasing, alongside rising delinquency rates, as consumers deplete their pandemic-era savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter, marking the second consecutive quarter that overall cardholder balances exceeded the trillion-dollar mark, according to TransUnion. Additionally, the commercial real estate market remains in a fragile state.
“We’re still emerging from the COVID period, particularly regarding banking and consumer health, which benefitted from stimulus measures,” commented Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, challenges for banks are expected to intensify in the coming months.
“The provisions you see each quarter do not necessarily reflect credit quality over the last three months; they indicate banks’ expectations for the future,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
“It’s interesting because we’ve transitioned from a traditional system where rising bad loans drove up provisions, to one where macroeconomic forecasts heavily influence provisioning,” he added.
In the short term, banks predict slowed economic growth, higher unemployment, and two interest rate cuts later in the year, which could lead to an increase in delinquencies and defaults by year-end.
Citigroup’s chief financial officer Mark Mason noted that these warning signs are particularly evident among lower-income consumers, who have experienced a decline in savings since the pandemic began.
“While the U.S. consumer remains overall resilient, we’re seeing varied performance and behavior across different income levels,” Mason stated during an analyst call. “Only the top income quartile has more savings compared to early 2019, with those in the over-740 FICO score range driving spending growth and maintaining high payment rates. Meanwhile, lower FICO band customers are facing more significant challenges.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it aims for inflation measures to stabilize at its 2% target before implementing the anticipated rate cuts.
Despite banks preparing for potential defaults in the latter half of the year, current default rates do not indicate a looming consumer crisis, according to Mulberry. He is particularly observing the difference in situations between homeowners and renters from the pandemic period.
“Yes, interest rates have increased significantly, but homeowners locked in very low fixed rates, so they are not feeling the pressure as much. In contrast, renters missed that opportunity,” Mulberry noted.
With rents having increased by over 30% nationwide from 2019 to 2023 and grocery costs climbing by 25% during the same timeframe, renters unable to secure low rates are experiencing considerable strain on their budgets.
Nonetheless, the main takeaway from the recent earnings reports is that “there were no new issues this quarter regarding asset quality,” Narron affirmed. Strong revenues, profits, and resilient net interest income suggest that the banking sector remains robust.
“There is strength in the banking sector that might not have been expected, and it’s reassuring to see that the financial system’s structures are still strong at this time,” Mulberry stated. “However, we are monitoring the situation closely, as prolonged high interest rates will invariably lead to more stress.”