As interest rates reach levels not seen in over two decades and inflation continues to affect consumers, major banks are bracing for more challenges related to their lending activities.
In the second quarter, leading banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions consist of funds set aside by financial institutions to account for potential losses from credit risks, which include overdue debts and loans, particularly in commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses during this period, while Bank of America allocated $1.5 billion. Citigroup reported a total allowance for credit losses of $21.8 billion by the end of the quarter, a figure that more than tripled its reserve increase from the previous quarter. Wells Fargo established provisions of $1.24 billion.
These increased provisions suggest that banks are preparing for a more uncertain economic landscape, where both secured and unsecured loans may lead to greater losses. According to a recent analysis from the New York Fed, total household debt in the U.S. has reached approximately $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
Furthermore, there has been a rise in credit card issuance and delinquency rates as people deplete their pandemic-era savings and increasingly rely on credit. The total credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter in which the overall balances surpassed the trillion-dollar threshold, as reported by TransUnion. The commercial real estate market also remains in a delicate position.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, stated, “We’re still emerging from the COVID period, and much of the health seen in banking and consumer finances can be attributed to the stimulus provided to consumers.”
Future challenges for banks are anticipated. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that the provisions seen in any quarter do not necessarily reflect the quality of credit for that period but rather what banks predict will occur moving forward.
He explained, “Historically, when loans started to default, provisions would increase. Now, the macroeconomic outlook plays a significant role in determining these provisions.”
In the near term, banks expect a slowdown in economic growth, a rise in unemployment, and potential interest rate reductions in September and December, which could lead to more delinquencies and defaults as the year closes.
According to Citigroup CFO Mark Mason, these concerns are primarily evident among lower-income consumers, who have seen their savings diminish since the pandemic began. “While we still observe a generally resilient U.S. consumer, we are also witnessing a performance gap based on FICO scores and income levels,” Mason indicated during a recent analyst call.
He elaborated that only the highest-income quartile has managed to save more compared to early 2019, with higher FICO score customers driving spending growth and maintaining strong payment rates. Conversely, individuals with lower FICO scores are facing greater declines in payment rates and are increasingly relying on borrowing due to the adverse impacts of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it awaits inflation metrics to stabilize toward its 2% target before implementing anticipated rate cuts.
Despite banks preparing for increased defaults in the latter half of the year, Mulberry asserts that defaults have not yet risen to a level that indicates an impending consumer crisis. He notes a key distinction between homeowners and renters from the pandemic period.
“While interest rates have surged since then, homeowners secured very low fixed rates on their debts and are not experiencing significant distress,” Mulberry explained. “In contrast, renters, who missed that opportunity, are now contending with a rental market that has escalated over 30% nationally since 2019.”
As rents have soared more than 30% across the country between 2019 and 2023, and grocery costs have increased by 25%, those tenants who could not lock in low rates are facing significant budget pressure.
Currently, the most noteworthy aspect of the recent earnings reports is that “there has been no new information this quarter regarding asset quality,” Narron remarked. The banking sector continues to show strong revenues, profits, and resilient net interest income, which are all signs of ongoing financial health.
“There is a measure of strength in the banking sector that might not have been entirely unexpected, but it is reassuring to note that the financial system remains robust and sound at this time,” Mulberry concluded. “However, it is important to monitor the situation closely, as prolonged high interest rates will inevitably create more strain.”