As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are gearing up to navigate increased risks related to their lending strategies.
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 funds that banks set aside to mitigate potential losses from credit risks, which include issues related to delinquent loans and bad debt, particularly in commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s credit loss allowance stood at $21.8 billion—more than tripling from the previous quarter; and Wells Fargo’s provisions amounted to $1.24 billion.
These increases demonstrate that banks are prepared for a more challenging lending environment, potentially leading to greater losses from both secured and unsecured loans. A recent report from the New York Federal Reserve showed that Americans currently owe a cumulative total of $17.7 trillion across various forms of consumer debt, including student loans and mortgages.
Moreover, the issuance of credit cards and the corresponding delinquency rates are rising as individuals exhaust their pandemic savings and increasingly depend on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter that the total balance 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, noted, “We’re still emerging from the COVID era, and the health of consumers was heavily reliant on the stimulus provided.”
However, experts warn that challenges for banks may arise in the upcoming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions are not just a reflection of recent credit quality but are indicative of anticipated future developments.
He added, “Historically, when loans began to deteriorate, provisions would increase, but we are now in a scenario where macroeconomic forecasts drive provisioning.”
In the immediate future, banks anticipate slower economic growth, rising unemployment rates, and potential interest rate cuts later this year, which could trigger more delinquency and defaults as the year concludes.
Citigroup’s CFO, Mark Mason, emphasized that those indications of trouble are predominantly seen among lower-income consumers, who have seen their savings diminish since the pandemic.
“While the U.S. consumer shows overall resilience, there’s a noticeable divergence in performance based on income and credit scores,” Mason said during an analyst call. “Only the highest income quartile has managed to increase their savings since early 2019, with those boasting over a 740 credit score driving growth in spending and maintaining high payment rates. Conversely, lower credit score individuals are experiencing declines in payment rates and are borrowing more amidst high inflation and interest rates.”
The Federal Reserve is maintaining interest rates at a two-decade high of 5.25-5.5%, awaiting stabilization in inflation measures towards its target of 2% before implementing anticipated rate cuts.
Despite banks preparing for a potential increase in defaults later this year, Mulberry points out that current default rates do not yet indicate a consumer crisis. He is particularly focused on the distinctions between homeowners and renters since the pandemic onset.
Although interest rates have risen significantly, homeowners benefitted from low fixed-rate mortgages and are less affected financially. In contrast, renters have faced over a 30% increase in rent since 2019 and a 25% rise in grocery costs, coupled with wage growth that hasn’t matched the surging rental prices—leading to heightened stress for those without locked-in low rates.
For now, commentary from the most recent earnings reports indicates that “there was nothing new this quarter in terms of asset quality,” according to Narron. Strong revenues, profits, and a resilient net interest income highlight the health of the banking sector.
“There is a robustness in the banking sector that may not be entirely surprising, but it is reassuring to observe the financial system’s structures remaining strong and sound at this moment,” Mulberry concluded. “We are closely monitoring the situation, as prolonged high interest rates could lead to increased strain.”