With interest rates at their highest in over 20 years and inflation continuing to impact consumers, major banks are bracing for increased risks stemming from their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all elevated their provisions for credit losses compared to the previous quarter. These provisions are reserves set aside to mitigate potential losses associated with credit risks, which include delinquent loans and troubled debts, notably in the commercial real estate sector.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses totaled $21.8 billion at the end of the quarter, more than tripling its reserves from the prior period. Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging environment where both secured and unsecured loans may lead to larger losses. According to a recent analysis by the New York Fed, Americans collectively owe $17.7 trillion across various debts, including consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates have risen as consumers exhaust their savings from the pandemic and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where totals surpassed the trillion-dollar mark, as reported by TransUnion. Commercial real estate remains particularly vulnerable amid these trends.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked, “We’re still coming out of this COVID era, and primarily, banking health and consumer stability were propped up by stimulus measures directed at consumers.”
However, challenges for banks are expected to surface in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that current provisions reflect banks’ expectations of future credit quality rather than recent trends.
“Historically, provisions increased when loans began to falter, but now macroeconomic forecasts primarily drive provisioning decisions,” he explained.
Banks are anticipating a slowdown in economic growth, a rise in unemployment, and potential interest rate cuts later this year, which could lead to more delinquencies and defaults as the year progresses.
Citi CFO Mark Mason emphasized that the warning signs mostly affect lower-income consumers who have seen their savings diminish post-pandemic. He stated, “While the overall U.S. consumer remains resilient, we observe a performance divergence across income brackets and credit scores.”
Only the highest income quartile has retained more savings than before 2019, with consumers in the top credit score brackets contributing to spending growth and maintaining high payment rates. In contrast, those in lower credit score categories are experiencing significant drops in payment rates and increased borrowing due to higher inflation and interest rates.
The Federal Reserve has maintained interest rates in the 5.25-5.5% range, the highest in 23 years, as it seeks to stabilize inflation toward its target of 2% before implementing anticipated rate cuts.
While banks prepare for potential defaults later in the year, current default rates do not yet suggest a consumer crisis. Mulberry noted that the situation differs for homeowners and renters, with homeowners benefiting from historically low fixed rates.
Despite rising rates since the pandemic, homeowners are generally insulated from financial strain, unlike renters who are facing increased rental prices and rising grocery costs that have far outpaced wage growth.
Overall, the most recent earnings reports indicate that there are no significant new concerns regarding asset quality. The banking sector continues to demonstrate strong revenues, profits, and net interest income, suggesting stability within the industry.
“There are aspects of strength in the banking sector that might not have been entirely expected,” Mulberry concluded. “However, with high interest rates persisting, we are mindful of the stress they may impose.”