With interest rates reaching levels not seen in over 20 years and inflation continuing to weigh down on consumers, major banks are bracing for increased risks associated with their lending activities.
In the second quarter of the year, 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 allocate to potentially cover losses from credit risk, including defaults and problematic loans, such as those in commercial real estate.
JPMorgan set aside $3.05 billion for credit losses during the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, marking a threefold increase from the prior quarter. Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves reflect banks’ anticipation of a more challenging lending environment, where both secured and unsecured loans may result in larger losses for some of the country’s leading banks. A recent report from the New York Fed highlighted that American households collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Additionally, the rise in credit card issuance has been accompanied by higher delinquency rates, as consumers begin depleting their pandemic-era savings and depend more on credit. TransUnion reported that credit card balances hit $1.02 trillion in the first quarter of the year, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold. Commercial real estate remains in a vulnerable position as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the lingering effects of the COVID-19 pandemic have impacted consumer health and banking practices due to the stimulus measures previously implemented.
Experts caution that potential issues for banks may arise in the coming months. Mark Narron, a senior director at Fitch Ratings, pointed out that current provisions are based less on past credit quality and more on future economic expectations.
Banks are anticipating slower economic growth, a rise in unemployment rates, and two interest rate cuts projected for September and December of this year, which could lead to increased delinquencies and defaults as the year draws to a close.
Mark Mason, Citigroup’s chief financial officer, highlighted that signs of trouble are particularly evident among lower-income consumers, who have seen their savings significantly diminish since the pandemic began.
While the overall U.S. consumer remains resilient, Mason indicated that there is a noticeable divergence in financial performance across different income groups. Only the highest income bracket has maintained greater savings compared to 2019 levels, with customers scoring above 740 on the FICO scale contributing to spending growth and high payment rates. In contrast, lower FICO score customers are experiencing declines in payment rates while increasing borrowing due to the impact of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting inflation measures to align with the central bank’s target of 2% before enacting anticipated rate cuts.
Despite banks preparing for an increase in defaults in the latter part of the year, current default rates do not indicate an imminent consumer crisis, according to Mulberry. He is particularly interested in the contrast between homeowners who secured low fixed rates during the pandemic and renters who did not have that opportunity.
While interest rates have risen significantly, Mulberry emphasized that homeowners are not feeling the financial strain as they locked in favorable rates on their debts. Renters, however, face a more difficult situation, with national rents increasing by more than 30% between 2019 and 2023, alongside a 25% rise in grocery prices during that time. Many renters are now wrestling with soaring costs that have outpaced wage growth.
For the moment, the key takeaway from the recent earnings reports is that there have been no significant changes in asset quality this quarter. Strong revenue, profits, and resilient net interest income suggest that the banking sector remains healthy.
Mulberry remarked on the stability within the financial system, expressing relief that the fundamental structure of the banking sector is still robust. However, he noted that prolonged high interest rates will inevitably increase pressure on banks.