With interest rates hitting levels not seen in over two decades and inflation increasingly affecting consumers, major banks are gearing up for additional challenges stemming from 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 that banks reserve to account for potential losses related to credit risk, which encompasses delinquent debts and lending such as commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, showing a threefold increase from the previous quarter. Wells Fargo reported $1.24 billion in provisions.
These increased reserves indicate that banks are preparing for a riskier financial environment, where both secured and unsecured loans could lead to greater losses. A recent analysis by the New York Fed revealed that American households collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as individuals deplete their pandemic-era savings and increasingly rely on credit. In the first quarter of this year, total credit card balances reached $1.02 trillion, marking the second consecutive quarter in which balances exceeded the trillion-dollar threshold, according to TransUnion. Furthermore, the commercial real estate sector remains precariously positioned.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the current state of banking and consumer health is largely a result of economic stimulus measures provided during the pandemic.
Challenges for banks are anticipated in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, pointed out that the provisions reported by banks may not accurately reflect credit quality for the past few months but instead illustrate expectations for the future.
Banks are forecasting slowed economic growth, higher unemployment rates, and two interest rate reductions later this year, which could lead to increased delinquencies and defaults as the year wraps up.
Citi’s chief financial officer Mark Mason highlighted that these warning signs are particularly evident among lower-income consumers who have seen their savings diminish since the pandemic’s onset. He noted that while the overall U.S. consumer remains resilient, there is a noticeable disparity in financial performance across different income and credit score brackets.
Only the highest income quartile has seen improvement in savings since early 2019, and customers with FICO scores above 740 are responsible for the growth in spending and maintaining high payment rates. Conversely, those in lower FICO score brackets are experiencing significant declines in payment rates and are borrowing more due to the impacts of rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting inflation indicators to stabilize closer to the central bank’s 2% target before implementing anticipated rate cuts.
Despite banks bracing for an increase in defaults, Mulberry noted that defaults have not yet surged to levels indicative of a consumer crisis. He is particularly observing the divide between homeowners and renters from the pandemic era.
While interest rates have substantially increased, homeowners locked in low fixed rates and are not currently feeling the financial strain. In contrast, renters, who could not benefit from these low rates, are facing heightened financial pressure as rents have surged by over 30% nationwide from 2019 to 2023, and grocery costs have risen by 25%.
For the time being, the key takeaway from the latest round of earnings reports is that there have been no new developments regarding asset quality. According to Narron, strong revenues, profits, and resilient net interest income remain positive indicators for the banking sector’s health.
Mulberry expressed that the banking sector exhibits strength that may not have been entirely expected, serving as a relief that the financial system remains robust. However, he cautioned that sustained high-interest rates could introduce more stress into the system.