As interest rates remain at their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for increased risks from their lending operations.
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 set aside to cover potential losses from credit risks, including delinquencies and bad debt, particularly related to commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter; Bank of America allocated $1.5 billion; Citigroup’s allowance for credit losses reached $21.8 billion as of the quarter’s end, more than triple the amount from the previous quarter; and Wells Fargo reported $1.24 billion in provisions.
These reserves highlight the banks’ preparations for a challenging environment, where both secured and unsecured loans might lead to significant losses. Recent data from the New York Federal Reserve indicates that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards is rising, along with delinquency rates, as many consumers deplete the savings accumulated during the pandemic and increasingly rely on credit. The total credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where the total exceeded the trillion-dollar milestone, according to TransUnion. CRE also faces ongoing challenges.
“We’re still emerging from the COVID era, and much of the consumer health was supported by stimulus measures,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any potential issues for banks are anticipated in the upcoming months. “The provisions reported for any quarter do not necessarily reflect the recent credit quality; they indicate the banks’ expectations for the future,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He added that the shift in the banking industry has moved from examining past loan performance to forecasting future economic conditions that drive provisioning decisions.
Looking ahead, banks are projecting a slowdown in economic growth, increased unemployment rates, and two anticipated interest rate cuts later this year, which could lead to higher delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, highlighted that warning signs are particularly evident among lower-income consumers, who have seen their savings decline since the pandemic. “While the overall U.S. consumer remains resilient, there’s a noticeable divide in performance and behavior across income and credit score bands,” Mason stated during a call with analysts earlier this month.
Mason noted that only the highest income bracket has maintained more savings than before 2019, and consumers with higher credit scores are driving spending growth and maintaining solid payment rates. Conversely, customers within lower credit score brackets are experiencing significant declines in payment rates and are borrowing more due to the impacts of elevated inflation and interest rates.
The Federal Reserve has kept interest rates at a 23-year high of 5.25%-5.5%, awaiting stabilization of inflation measures toward the central bank’s 2% target before considering rate cuts.
Despite banks preparing for increased defaults later in the year, defaults are not currently rising at a rate indicative of a consumer crisis, according to Mulberry. He is particularly monitoring the differences between homeowners and renters from the pandemic period.
“While rates have increased significantly, homeowners secured low fixed rates on their debts, so they are less adversely affected. Renters, on the other hand, missed that opportunity,” Mulberry noted.
With rents increasing over 30% nationally from 2019 to 2023 and grocery costs rising by 25% during the same period, renters without locked-in low rates are feeling the most financial strain, he confirmed.
So far, the key takeaway from the latest earnings reports is that “there was nothing new this quarter regarding asset quality.” The sector continues to show strong revenues, profits, and a solid net interest income, signaling a healthy banking environment.
“There are signs of strength within the banking sector that may not have been entirely anticipated, but it is certainly a relief to acknowledge that the structures of the financial system remain robust,” Mulberry concluded. “However, as long as interest rates stay elevated, additional stress could arise.”