As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing 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 prior quarter. These provisions represent funds set aside by financial institutions to address potential losses from credit risks, including delinquent loans and lending activities such as commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America earmarked $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, which is more than triple the amount set aside in the previous quarter, and Wells Fargo recorded $1.24 billion in provisions.
This increase in provisions indicates that banks are preparing for a more challenging environment, where both secured and unsecured loans could lead to greater losses. According to the New York Fed, Americans currently owe a total of $17.7 trillion in consumer, student, and mortgage loans.
Credit card issuance has risen, along with delinquency rates, as many consumers exhaust their pandemic savings and increasingly rely on credit. As of the first quarter of this year, credit card balances hit $1.02 trillion, marking the second consecutive quarter in which total cardholder balances exceeded a trillion dollars, according to TransUnion. The commercial real estate sector also remains in a vulnerable position.
“We’re still recovering from the COVID era, especially in terms of banking and consumer health, which were heavily influenced by the stimulus provided to consumers,” remarked Brian Mulberry, a portfolio manager at Zacks Investment Management.
However, banks may face issues in the future. Mark Narron, a senior director at Fitch Ratings, explained that quarterly provisions may not accurately reflect recent credit quality; rather, they indicate banks’ future expectations.
Narron emphasized the shift from a system where increasing loan defaults led to higher provisions, to one where the broader economic forecast drives these provisions. In the near future, banks anticipate slowing economic growth, higher unemployment rates, and two interest rate cuts later this year, which could lead to more delinquencies and defaults.
Citi’s CFO Mark Mason pointed out that financial red flags are primarily appearing among lower-income consumers, whose savings have diminished since the pandemic. “While the overall U.S. consumer appears resilient, there is a clear divergence in performance and behavior based on income levels and credit scores,” Mason stated.
He noted that only the highest income quartile has more savings than before 2019, while customers with FICO scores above 740 are responsible for the growth in spending and maintaining high payment rates. In contrast, those with lower FICO scores are experiencing declines in payment rates and borrowing more, largely due to the effects of rising inflation and interest rates.
The Federal Reserve has kept interest rates between 5.25% and 5.5%, the highest in 23 years, as it waits for inflation to stabilize around its 2% target before implementing anticipated rate cuts.
Despite banks preparing for increased defaults later in the year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He believes the situation varies between homeowners and renters. “While rates have risen significantly, homeowners have locked in low fixed rates, so they haven’t felt the same financial pressure as renters who couldn’t take advantage of that opportunity,” Mulberry explained.
With rents surging more than 30% nationwide and grocery prices climbing 25% from 2019 to 2023, renters are facing greater financial strain than homeowners.
For now, industry experts maintain that the banking sector remains strong. Narron noted, “There were no significant changes in asset quality this quarter. The banking sector’s solid revenues, profits, and net interest income signals a healthy landscape.”
Mulberry echoed this sentiment, asserting that while the financial system is currently robust, sustained high interest rates could lead to future stress.