As interest rates reach their highest levels in over two decades and inflation continues to affect consumers, major banks are preparing for increased risks associated with their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions are funds that banks set aside to absorb potential losses stemming from credit risks, such as delinquent loans and other forms of bad debt, including 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 rose to $21.8 billion by the quarter’s end, significantly up from previous levels, and Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a more volatile financial environment, where both secured and unsecured loans could lead to greater losses for some of the country’s largest financial institutions. An analysis from the New York Federal Reserve recently highlighted that U.S. consumers collectively owe $17.7 trillion in various loans, including consumer debt, student loans, and mortgages.
Credit card issuance is also on the rise, along with higher delinquency rates, as many individuals deplete their pandemic-era savings and increasingly rely on credit. As reported by TransUnion, total credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances exceeded the trillion-dollar threshold. The CRE sector, too, remains in a vulnerable situation.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, stated that the ongoing recovery from the COVID-19 pandemic has been significantly influenced by the stimulus efforts targeted at consumers.
However, challenges for the banking sector are expected to emerge in the upcoming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that the credit provisions reported by banks do not solely reflect credit quality from recent months; rather, they represent forecasted expectations for the future.
This shift diverges from historical trends where a rise in bad loans would typically trigger an increase in credit provisions. Now, provisions are more closely tied to the macroeconomic outlook, which currently suggests slowing growth, a rise in unemployment, and potential interest rate cuts later in the year.
Citi’s chief financial officer, Mark Mason, highlighted a concerning trend among lower-income consumers who have seen their savings diminish since the pandemic. While the overall U.S. consumer remains resilient, Mason pointed out a notable disparity in behavior based on credit score and income levels.
Data shows that only the highest income quartile has managed to save more than they had before 2019, with those holding credit scores above 740 accounting for significant spending growth and high payment rates. In contrast, consumers in lower credit score brackets are struggling more, facing increased borrowing and declining payment rates due to the combined impact of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, waiting for inflation to stabilize toward its 2% target before considering any significant rate cuts.
Though banks are preparing for a rise in defaults as the year progresses, industry experts like Mulberry believe that current default rates do not indicate an impending consumer crisis. He noted that a key focus will be the distinction between those who were homeowners during the pandemic and renters.
Although interest rates have surged, Mulberry observed that homeowners locked in low fixed rates on their debts and are not experiencing the same financial pressure. Conversely, renters, who did not have the opportunity to secure favorable rates, are facing significant stress as rental prices have surged over 30% nationally from 2019 to 2023, and grocery costs have risen by 25%.
Currently, the most significant takeaway from recent earnings reports is that there have been no alarming changes in asset quality. Strong revenues, profit margins, and robust net interest income continue to show that the banking sector remains healthy.
Mulberry emphasized that the overall strength of the financial system is reassuring, but warned that prolonged high interest rates could lead to increased stress for consumers and financial institutions alike.