With interest rates reaching levels not seen in over 20 years and inflation continuing to pressure consumers, major banks are bracing themselves for increased risks associated with 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 are funds set aside by financial institutions to cover potential losses from credit risk, which can include delinquent loans and bad debts, particularly in areas like commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses amounted to $21.8 billion by the end of the quarter, more than tripling its reserves from the previous quarter. Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans could lead to larger losses for some of the largest financial institutions in the country. A recent analysis by the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise as individuals deplete their pandemic-era savings and increasingly turn to credit. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total balances surpassed the trillion-dollar threshold. Additionally, the commercial real estate sector continues to face significant vulnerabilities.
As Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted, the impacts of the COVID era are still felt in banking and consumer health, largely due to the substantial stimulus provided to consumers.
However, any significant issues for banks are anticipated in the future. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that the provisions reported by banks do not solely reflect credit quality from the past three months, but rather what banks expect to occur moving forward.
He highlighted a shift from a traditional system, where increasing bad loans would directly correlate with rising provisions, to a model where macroeconomic forecasts predominantly drive provisioning.
In the near future, banks are anticipating slower economic growth, a higher unemployment rate, and two anticipated interest rate cuts later this year, which could lead to more delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, pointed out that the emerging concerns seem to be primarily among lower-income consumers who have seen their savings diminish since the pandemic.
“While we continue to observe an overall resilient U.S. consumer, we also see a divergence in performance and behavior across different income levels and credit scores,” Mason remarked during a recent analyst call.
He noted that only the highest income quartile has accumulated more savings compared to the beginning of 2019, and it is primarily consumers with high credit scores driving spending and maintaining solid payment rates. Conversely, consumers with lower credit scores are experiencing significant declines in payment rates and are borrowing more due to the adverse effects of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a peak of 5.25-5.5% for 23 years as it awaits stabilization in inflation towards the central bank’s target of 2% before implementing expected rate cuts.
Despite preparations by banks for increased defaults in the latter part of the year, Mulberry noted that current default rates do not indicate a consumer crisis. He is particularly observing the differences between homeowners and renters during the pandemic.
“Homeowners locked in very low fixed rates on their debt despite the substantial rate increases since then, which means they are less affected by rising costs,” Mulberry explained, contrasting their situation with that of renters who have faced steep rent increases.
Between 2019 and 2023, rents rose more than 30% nationwide, alongside a 25% increase in grocery costs, placing significant financial strain on renters whose incomes have not kept pace with these rises.
For now, the latest earnings reports suggest that the banking sector remains robust, with Narron stating that “there was nothing new this quarter in terms of asset quality.” Strong revenues, profits, and resilient net interest income are signs of a healthy banking system.
“There’s a degree of strength in the banking sector that was somewhat expected, but it is reassuring to confirm that the structure of the financial system remains stable,” Mulberry concluded. “However, we are closely monitoring the situation, as prolonged high interest rates will inevitably lead to more stress.”