As interest rates reach their highest levels in over 20 years and inflation continues to pressure consumers, major banks are bracing for possible challenges in their lending operations.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions are funds that banks reserve to cover potential losses from defaults, including bad debt and loans such as commercial real estate (CRE) financing.
JPMorgan set aside $3.05 billion for credit losses, while Bank of America allocated $1.5 billion. Citigroup’s credit loss allowance climbed to $21.8 billion by the end of the quarter, more than tripling its reserves from the previous quarter. Wells Fargo’s provisions amounted to $1.24 billion.
The increased reserves signal that banks are preparing for a riskier environment, where both secured and unsecured loans could lead to greater losses. A recent analysis from the New York Fed revealed that American households collectively owe $17.7 trillion in various forms of debt, including consumer and student loans, as well as mortgages.
Additionally, credit card issuance and delinquency rates have risen as consumers deplete their pandemic-era savings and increasingly depend on credit. Credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. The CRE sector also remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted, “We’re still coming out of this COVID era, especially regarding banking and consumer health, which were significantly influenced by the stimulus measures.”
Challenges for banks may emerge in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that provisions reflect banks’ expectations for the future rather than their recent credit quality.
He added, “Historically, when loans started to perform poorly, provisions would increase, but now, the macroeconomic outlook largely drives provisioning.”
In the near term, banks anticipate slower economic growth, a rise in unemployment rates, and two planned interest rate cuts later this year. This scenario could lead to increased delinquencies and defaults by the end of the year.
Citi’s chief financial officer, Mark Mason, pointed out that signs of distress are emerging, particularly among lower-income consumers who have seen their savings diminish since the pandemic began. He stated that while the overall U.S. consumer remains resilient, disparities in financial performance are noticeable across different income levels.
Mason remarked, “Only the highest income quartile has increased their savings since early 2019, and it is those with FICO scores above 740 who are driving spending growth and maintaining payment rates.” In contrast, customers with lower FICO scores are experiencing a drop in payment rates and are borrowing more due to the impacts of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% while awaiting stabilization in inflation metrics before implementing anticipated rate cuts.
Despite expectations for increased defaults later this year, current default rates do not suggest an imminent consumer crisis, according to Mulberry. He is particularly observing the situation for homeowners versus renters.
Mulberry explained that while interest rates have risen significantly, homeowners have secured low fixed rates on their debts, so they aren’t feeling the same financial pressures as renters. With rents rising over 30% nationally from 2019 to 2023 and food costs climbing by 25% in that timeframe, renters are facing the most financial strain as their budgets adjust.
For now, the latest earnings reports indicate stability within the banking sector, with no significant new concerns regarding asset quality. Resilient revenue, profits, and strong net interest income are positive signs for the industry.
“There’s some strength in the banking sector, which might not have been entirely unexpected, but it’s reassuring to see the financial system’s structures are still robust,” Mulberry concluded. “However, we are keeping a close watch, as prolonged high interest rates will create additional stress.”