With interest rates reaching their highest levels in over two decades and consumers facing continued inflationary pressure, major banks are bracing for increased risks in their lending activities.
In the second quarter of this year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses from the previous quarter. These provisions are funds set aside by financial institutions to mitigate potential losses linked to credit risks, including overdue debts and loans related to commercial real estate.
JPMorgan set aside $3.05 billion for credit losses in the second quarter; Bank of America allocated $1.5 billion; Citigroup’s allowance reached $21.8 billion, more than tripling its reserves from the previous quarter; while Wells Fargo reported provisions of $1.24 billion.
These reserve increases indicate that banks are preparing for a more challenging financial landscape, with both secured and unsecured loans potentially leading to greater losses. An analysis by the New York Federal Reserve revealed that American households collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
As pandemic-era savings diminish, credit card usage and delinquency rates are on the rise. Credit card balances soared to $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances exceeded a trillion dollars, according to TransUnion. Additionally, the commercial real estate sector remains uncertain.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked on the ongoing effects of the COVID-19 pandemic and government stimulus on consumers and banks.
Looking ahead, however, potential issues for banks may arise in the coming months.
Mark Narron, senior director in Fitch Ratings’ Financial Institutions Group, explained that quarterly provisions do not always correlate with credit quality from the past three months but rather reflect banks’ expectations for future trends.
He noted a shift from historical practices where bad loans prompted increased provisions to a model where macroeconomic forecasts dictate provisioning strategies.
Currently, banks anticipate slower economic growth, a rise in unemployment, and two possible interest rate cuts later this year in September and December, which could lead to increased delinquency and default rates as the year progresses.
Citi’s chief financial officer, Mark Mason, highlighted concerning trends among lower-income consumers, who have seen their savings decline since the pandemic.
While the U.S. consumer shows overall resilience, Mason pointed out stark differences in financial behavior across income levels and credit scores. Only the wealthiest quartile has maintained increased savings since early 2019, with higher-income clients and those with credit scores above 740 driving spending growth and maintaining high payment rates. Conversely, lower-income borrowers are experiencing a decline in payment rates and are borrowing more due to heightened inflation and interest costs.
The Federal Reserve has kept interest rates steady at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation rates towards its 2% target before considering anticipated rate cuts.
Despite preparations for potential broader defaults this year, current data do not indicate an imminent consumer crisis, Mulberry noted. He is particularly interested in the divergence in experiences between homeowners and renters, stating that homeowners secured low fixed rates during the pandemic, whereas renters did not benefit from such opportunities.
With national rental prices rising over 30% and grocery costs increasing by 25% from 2019 to 2023, renters face significant financial pressure as their budgets struggle to keep pace with these costs.
Overall, the recent earnings reports indicate no new concerns regarding asset quality, according to Narron. Impressive revenues, profits, and net interest income suggest a robust banking industry.
Mulberry emphasized that there remains strength within the banking sector, which offers some reassurance, but cautioned that prolonged high interest rates may induce further stress in the future.