With interest rates at their highest levels in over 20 years and inflation putting pressure on 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 the funds banks set aside to offset potential losses from credit risks, which can include delinquent debts and commercial real estate loans.
JPMorgan added $3.05 billion to its provision for credit losses during this period; Bank of America reported $1.5 billion; Citigroup’s allowance reached $21.8 billion, more than tripling from the previous quarter; while Wells Fargo set aside $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans might lead to greater losses. A recent report by the New York Fed highlighted that American households now owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance and delinquency rates of credit cards have been rising as people deplete their savings accumulated during the pandemic 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 they exceeded the trillion dollar mark, according to TransUnion. Additionally, commercial real estate remains in a vulnerable state.
“We’re still recovering from the COVID-19 pandemic, particularly regarding banking and consumer health, largely due to the stimulus provided,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, the impacts on banks are expected to manifest in the coming months.
“The provisions you see in any given quarter don’t necessarily reflect the credit quality over the last three months; they are predictions of future outcomes,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
He noted a shift from a historical pattern, where increasing loan defaults led to higher provisions, to a more proactive approach where economic forecasts shape these reserves.
Looking ahead, banks anticipate slower economic growth, a rise in unemployment, and the prospect of two interest rate cuts late this year, likely in September and December. This could lead to an uptick in delinquencies and defaults as the year progresses.
Citi’s chief financial officer, Mark Mason, highlighted that concerning trends seem more pronounced among lower-income consumers, who have seen their savings diminish since the pandemic.
“While the overall U.S. consumer remains resilient, performance varies significantly across income levels and credit scores,” Mason noted in a recent analyst call.
He observed that only the highest income quartile has increased savings since early 2019, and customers with high credit scores are driving spending and maintaining timely payments. In contrast, lower credit score borrowers are experiencing a decline in payment rates and are borrowing more, affected heavily by inflation and rising interest rates.
The Federal Reserve continues to maintain interest rates at a high of 5.25-5.5%, waiting for inflation indicators to stabilize around its 2% target before proceeding with anticipated rate cuts.
Despite banks preparing for more defaults in the latter half of the year, Mulberry stated that current default rates do not suggest an impending consumer crisis. He is particularly observing the divide between homeowners and renters from the pandemic period.
“Although rates have increased significantly, homeowners benefited from locking in low fixed rates, so they aren’t feeling the same pressure,” Mulberry said. “Renters, on the other hand, missed that opportunity.”
With rental prices rising over 30% nationally from 2019 to 2023 and grocery costs up 25% during the same timespan, renters facing escalating expenses relative to stagnant wage growth are feeling the financial squeeze more acutely.
Overall, the recent earnings reports indicate that “there was nothing new in terms of asset quality this quarter,” Narron asserted. High revenues, profits, and strong net interest income are all encouraging signs of a healthy banking sector.
“There’s strength in the banking system that, while not completely unexpected, is reassuring. The financial framework remains robust at this point,” Mulberry added. “However, we are closely monitoring the situation; prolonged high interest rates will inevitably lead to increased pressure.”