With interest rates at their highest in over 20 years and inflation heavily impacting consumers, major banks are gearing up for potential risks 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 are funds set aside by banks to cover anticipated losses from credit risks, including defaults on loans and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America reserved $1.5 billion. Citigroup’s allowance for credit losses climbed to $21.8 billion by the end of the quarter, marking more than a tripling of its reserve from the prior quarter. Wells Fargo reported $1.24 billion in provisions.
This buildup indicates that banks are preparing for a tougher lending environment, where both secured and unsecured loans may lead to greater losses. A recent analysis from the New York Federal Reserve revealed that American households collectively owe $17.7 trillion across various consumer, student, and mortgage loans.
Credit card issuance and delinquency rates are also on the rise as consumers exhaust their pandemic savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that totals exceeded the trillion-dollar threshold, according to TransUnion. The commercial real estate sector is also facing challenges.
Brian Mulberry, client portfolio manager at Zacks Investment Management, noted that the banking situation is still evolving post-COVID, particularly regarding consumer health linked to the stimulus measures introduced during the pandemic.
Many of the upcoming challenges for banks are expected to manifest in the following months. Mark Narron, a senior director with Fitch Ratings, commented that the provisions reported by banks do not necessarily reflect the credit quality observed in the previous quarter, but rather what they anticipate in the future.
He added that there has been a shift from the traditional model, where rising loan defaults directly prompted increased provisions, to one where macroeconomic forecasts heavily influence provisioning decisions.
In the near future, banks predict a slowdown in economic growth, a rise in unemployment, and two interest rate cuts expected later this year in September and December. This could lead to more delinquencies and defaults as the year ends.
Citigroup’s CFO, Mark Mason, highlighted concerns regarding lower-income consumers, who have depleted their savings since the pandemic began. He observed a divergence in consumer behavior based on income and credit scores.
“Across our consumer clients, only those in the highest income bracket have more savings now compared to early 2019,” Mason noted. “High FICO score customers are responsible for spending growth and maintaining strong payment rates, while those with lower scores are borrowing more as they struggle with high inflation and interest rates.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, waiting to see inflation stabilize around its 2% target before implementing anticipated rate cuts.
Despite banks preparing for potential defaults later in the year, they have yet to see a surge that indicates a consumer crisis, according to Mulberry. He is particularly focused on the differences between homeowners and renters.
Homeowners, who secured low fixed-rate mortgages, are not feeling the financial strain as acutely as renters, who face skyrocketing housing costs. Nationwide rental rates surged over 30% between 2019 and 2023, along with a 25% increase in grocery costs. Renters lacking the opportunity to lock in lower rates are experiencing significant financial stress under these circumstances.
Overall, the latest earnings reports indicate stability within the banking sector. Narron remarked that there were no surprising changes regarding asset quality this quarter, with strong revenues and net interest income suggesting a resilient banking environment.
Mulberry added that the banking sector shows strength, offering some reassurance that the financial system remains robust, although prolonged high-interest rates may increase stress on the system.