As interest rates reach their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for increased risks linked to their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all raised their provisions for credit losses from the previous quarter. These provisions represent the funds that banks allocate to cover potential losses from credit risks, such as delinquent payments and bad debts, including 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 credit loss allowance reached $21.8 billion, more than triple the amount of the previous quarter; and Wells Fargo recorded provisions of $1.24 billion.
These increased reserves suggest that banks are preparing for a more uncertain environment, where both secured and unsecured loans could result in greater losses for some of the country’s largest financial institutions. A recent analysis from the Federal Reserve Bank of New York showed that Americans have accumulated a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as consumers deplete their pandemic-era savings and increasingly rely on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter in which total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector is also facing significant challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted, “We’re still coming out of this COVID era, and primarily regarding banking and consumer health, there was a lot of stimulus that the government deployed to consumers.”
However, potential challenges for banks may surface in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, pointed out that the current provisions reflect banks’ expectations for the future rather than recent credit quality.
He explained, “It’s interesting because we’ve shifted from a system where provisions increased once loans began to default to one where macroeconomic forecasts significantly influence provisioning.”
In the near future, banks anticipate slowed economic growth, rising unemployment rates, and two interest rate cuts in September and December. This could lead to further delinquencies and defaults as the year concludes.
Mark Mason, Citigroup’s chief financial officer, remarked that these warning signs seem to be most pronounced among lower-income consumers, who have seen their savings diminish since the pandemic began.
“While we continue to see an overall resilient U.S. consumer, we also note a divergence in performance and behavior among different income groups and credit scores,” Mason stated during a recent analyst call. Only consumers in the highest income quartile have maintained more savings compared to 2019, largely leading the growth in spending, while those with lower credit scores are experiencing declines in payment rates and are increasingly borrowing as they struggle with high inflation and rising interest rates.
The Federal Reserve has kept interest rates at a range of 5.25-5.5%, their highest in 23 years, awaiting stabilization of inflation near the target of 2% before implementing anticipated rate cuts.
Despite the banks’ preparations for potential defaults later in the year, Mulberry adds that current default rates do not yet indicate a consumer crisis. He is currently observing the distinction between homeowners and renters during the pandemic.
He explained, “Homeowners had the opportunity to secure low fixed rates on their debt, and as a result, they aren’t feeling the sting as much. In contrast, renters lacked that option.”
With rents increasing more than 30% nationally from 2019 to 2023 and grocery costs rising by 25% in the same period, renters, who couldn’t lock in lower rates, are now facing intense budgeting pressures.
Nevertheless, the latest earnings reports indicate that “there was nothing new this quarter concerning asset quality.” Strong revenues, profits, and consistent net interest income are reassuring signs of a robust banking sector.
“There is strength in the banking sector that might not have been entirely anticipated, but it is indeed relieving to see that the financial system’s structures remain solid and stable at this moment,” Mulberry said. However, he cautioned that maintaining high interest rates for extended periods could lead to increased stress within the sector.