As interest rates reach heights not seen in over two decades and inflation continues to impact consumers, major banks are preparing to navigate increased risks in their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all heightened 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, including defaulted loans and commercial real estate (CRE) lending.
JPMorgan allocated $3.05 billion for credit losses, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, significantly increasing its reserves from the preceding quarter. Wells Fargo contributed $1.24 billion to its provisions.
The increased provisions indicate that banks are bracing for a more challenging environment, anticipating greater losses from both secured and unsecured loans. A recent analysis from the New York Federal Reserve revealed that total household debt in the U.S. stands at $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
The rising rate of credit card issuance and corresponding delinquency rates reflects that many consumers are exhausting their savings from the pandemic and turning more to credit. In fact, credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter in which debt levels exceeded the trillion-dollar threshold, as reported by TransUnion. Additionally, the state of commercial real estate continues to be precarious.
“We’re still emerging from the COVID era, particularly regarding banking and consumer health,” noted Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Challenges for the banks are expected to emerge in the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, explained that the provisions recorded in any given quarter are indicators of anticipated future credit quality rather than reflections of the recent past. “Historically, provisions would increase as loans began to falter, but we have shifted to a model where macroeconomic forecasts largely dictate provisioning,” he added.
For the near future, banks expect to see slower economic growth, a rise in unemployment, and two potential interest rate cuts by the Federal Reserve in September and December, which could lead to more delinquencies and defaults by the year’s end.
Citi’s CFO Mark Mason pointed out that the signs of financial stress are primarily concentrated among lower-income consumers, who have seen their savings deplete since the pandemic. “While the U.S. consumer remains overall resilient, there’s a noticeable divergence in performance across different income and credit score levels,” Mason remarked.
Currently, only the top income quartile has managed to maintain higher savings than at the start of 2019, with those in the higher FICO score brackets continuing to increase spending and keep up with payments. Conversely, customers with lower FICO scores are experiencing sharper declines in their payment rates and are relying more heavily on borrowing, feeling the impacts of higher inflation and interest rates.
Even though the Federal Reserve has maintained interest rates at a 23-year peak of 5.25-5.5%, awaiting inflation to stabilize around the 2% target before implementing anticipated cuts, a consumer crisis has yet to manifest, according to Mulberry. He highlighted the differing experiences of homeowners and renters during this period.
“Homeowners secured low fixed rates despite significant interest rate hikes,” Mulberry explained, noting that they are less affected financially. In contrast, renters, lacking the benefit of locked-in rates and facing rising rents—up over 30% from 2019 to 2023—along with grocery costs that have surged 25% during the same timeframe, are experiencing more financial pressure.
Currently, the earnings reports from banks suggest stability in asset quality. Despite the rising economic headwinds, strong revenues, profits, and healthy net interest income reflect that the banking sector remains robust.
According to Mulberry, “The banking sector is showing strength, which is somewhat reassuring, indicating that the financial system remains sound. However, we must remain vigilant, as extended periods of high interest rates can escalate stress levels.”