As interest rates remain at their highest levels in over two decades and inflation continues to challenge 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 previous quarter. These provisions represent funds that banks set aside to cover potential losses from credit risks such as delinquent loans and bad debt, including commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses, while Bank of America set aside $1.5 billion. Citigroup’s allowance rose significantly to $21.8 billion, more than tripling its reserves from the previous quarter, and Wells Fargo established provisions of $1.24 billion.
These increased provisions suggest that banks are preparing for a more challenging lending environment, where both secured and unsecured loans could lead to greater losses. According to a recent analysis by the New York Federal Reserve, American households carry a collective debt of $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as consumers deplete their pandemic-era savings and increasingly turn to credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter where total balances exceeded the trillion-dollar milestone, as reported by TransUnion. Additionally, the commercial real estate sector remains vulnerable.
“We are still emerging from the COVID era, particularly in relation to banking and consumer health, heavily influenced by the stimulus measures that were provided,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, challenges for banks are expected to manifest in the coming months. “The provisions recorded in any quarter do not necessarily reflect the credit quality from the past three months but rather what banks anticipate might occur in the future,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He added, “We have transitioned from a historical approach where loan defaults would trigger higher provisions, to a framework where macroeconomic forecasts primarily dictate provisioning.”
In the short term, banks anticipate slowing economic growth, rising unemployment rates, and potential interest rate cuts in September and December. This scenario could lead to increased delinquencies and defaults as the year draws to a close.
Citi’s chief financial officer, Mark Mason, highlighted that the risks are primarily concentrated among lower-income consumers, who have seen their savings diminish since the pandemic.
“While the overall U.S. consumer remains resilient, there is a growing divergence in performance and behavior across different income and credit score segments,” Mason noted during a recent analyst call. He pointed out that only the highest income quartile has increased savings since early 2019, with high credit score consumers driving spending growth and maintaining payment rates. Conversely, those in lower credit score brackets are experiencing significant drops in payment rates and are borrowing more, facing greater challenges due to high inflation and interest rates.
The Federal Reserve continues to hold interest rates at a 23-year high of 5.25-5.5% while awaiting stabilization in inflation to around its 2% target before implementing anticipated rate cuts.
Despite preparations for increased defaults later in the year, Mulberry emphasized that current rates of default do not indicate an impending consumer crisis. He is particularly observing the differences between homeowners and renters from the pandemic period.
“Yes, rates have increased significantly, but homeowners locked in low fixed rates on their debts and are not feeling the same financial strain,” he explained. “Renters, on the other hand, missed that opportunity.”
With rent prices soaring over 30% nationwide between 2019 and 2023, and grocery costs rising by 25% in the same timeframe, renters are facing considerable stress in their monthly budgets, as noted by Mulberry.
For now, the key takeaway from the recent earnings reports is the absence of significant new issues related to asset quality. The banking sector continues to demonstrate strong revenues, profits, and robust net interest income, reflecting its overall health.
“There is a level of strength in the banking sector that was not entirely unexpected, but it’s reassuring to observe that the foundations of the financial system remain robust at this juncture,” Mulberry stated. “However, we must remain vigilant, as prolonged high interest rates will inevitably impose additional stress.”