Amid soaring interest rates, which have hit their highest levels in over 20 years, and persistent inflation affecting consumers, major banks are bracing for potential risks linked to their lending activities.
In the second quarter of this year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions, essentially funds set aside to mitigate potential losses from credit risk, cover issues related to delinquent debts and loans, including those tied to commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup saw its allowance for credit losses surge to $21.8 billion at the end of the quarter, more than tripling its reserves from the previous quarter. Wells Fargo also reported provisions totaling $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans may incur larger losses. A recent study by the New York Fed highlighted that American households carry a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are climbing as pandemic savings dwindle and consumers turn to credit for financial support. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total balances exceeded the trillion-dollar threshold. The commercial real estate sector also remains precarious.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented, “We’re still emerging from the COVID era, and much of the consumer banking health relates to the stimulus provided during the pandemic.”
However, the real impact on banks is anticipated in the upcoming months. Mark Narron, a senior director at Fitch Ratings, noted that current provisions do not solely reflect recent credit quality but instead project future trends. “We’ve shifted from a system where rising loan defaults led to increased provisions to one where macroeconomic forecasts drive those reserves,” he explained.
In the short term, banks foresee slowing economic growth, a rise in unemployment, and anticipated interest rate cuts later this year. These factors could lead to increased delinquency and default rates as the year progresses.
Citigroup’s CFO, Mark Mason, pointed out that concerning trends appear to be concentrated among lower-income consumers, who have exhausted much of their savings since the pandemic began. He stated, “While the overall U.S. consumer remains resilient, we observe a divergence in performance based on income and credit scores.”
Mason highlighted that only the highest income quartile has maintained higher savings compared to early 2019, with spending growth largely driven by consumers with FICO scores above 740. In contrast, those in lower credit bands are experiencing declining payment rates and increasing borrowing needs, significantly affected by high inflation and rising interest rates.
The Federal Reserve has kept interest rates at a two-decade high of 5.25-5.5%, awaiting stabilization of inflation toward its 2% target before implementing the anticipated rate cuts.
Despite banks preparing for increased defaults in the latter part of the year, analysts like Mulberry note that the current rate of defaults does not indicate a consumer crisis at this moment. He is particularly attentive to the contrast between homeowners and renters during the pandemic. Homeowners who secured low fixed rates on their mortgages are largely shielded from current financial strains, unlike renters facing rising housing costs.
Taking into account a nationwide increase of over 30% in rent between 2019 and 2023 and a 25% rise in grocery prices, renters have been under significant financial pressure as their costs outpace wage growth.
Thus far, the latest earnings reports show that “there was nothing new this quarter in terms of asset quality,” according to Narron. Robust revenues, profits, and strong net interest income portray a banking sector that remains fundamentally sound.
Mulberry emphasized that while the current state of the banking sector is reassuring, the endurance of elevated interest rates is a growing concern. “The longer interest rates stay high, the more stress it causes,” he concluded.