As interest rates reach their highest level in over two decades and inflation continues to impact consumers, major banks are bracing for increased risks associated with their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks allocate to cover potential losses from credit risks, including delinquent debts and commercial real estate loans.
JPMorgan set aside $3.05 billion for credit loss provisions in the second quarter, while Bank of America increased its provisions to $1.5 billion. Citigroup reported a total of $21.8 billion in credit loss allowances, more than tripling its reserve from the previous quarter. Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves indicate that banks are preparing for a challenging economic landscape, where both secured and unsecured loans may lead to more significant losses. A recent analysis from the New York Fed highlighted that total household debt in the U.S. has reached $17.7 trillion, encompassing various forms of loans.
Moreover, credit card issuance is rising, accompanied by increasing delinquency rates, as many consumers are depleting their pandemic-era savings and increasingly relying on credit. In the first quarter, credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. Additionally, the commercial real estate sector remains under pressure.
According to Brian Mulberry, a portfolio manager at Zacks Investment Management, the aftereffects of COVID-19, particularly government stimulus measures, are still influencing banking conditions and consumer health.
However, any significant challenges for banks are expected to manifest in the upcoming months. Mark Narron, a senior director at Fitch Ratings, emphasized that the provisions set aside by banks reflect their future expectations rather than past credit quality.
Narron noted that banks foresee slower economic growth, rising unemployment, and two anticipated interest rate cuts later this year, which could result in more delinquencies and defaults as the year progresses.
Citi’s chief financial officer, Mark Mason, pointed out that signs of concern are primarily emerging among lower-income consumers, whose savings have diminished since the pandemic began. He observed that while the overall U.S. consumer remains resilient, there is a noticeable divergence in financial behaviors based on income and credit scores.
Mason indicated that only the highest-income quartile has more savings than at the start of 2019, with those having a FICO score above 740 driving spending growth and maintaining high payment rates. In contrast, lower FICO score customers are experiencing sharper declines in payment rates and are more vulnerable to the effects of inflation and high interest rates.
The Federal Reserve has kept interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation measures toward its 2% target before implementing the anticipated rate cuts.
Despite the banks’ preparations for increased defaults, signs of a consumer crisis are not yet evident, according to Mulberry. He highlighted the divergence between homeowners and renters; homeowners, having secured low fixed rates on their debts, are largely insulated from rate increases, while renters face increased financial strain.
Rental prices have surged by over 30% nationwide from 2019 to 2023, alongside a 25% rise in grocery costs, creating significant stress for renters who did not benefit from fixed low rates and are now contending with rising living costs.
The recent earnings reports indicate stability in the banking sector, with no major concerns regarding asset quality. Strong revenues, profits, and healthy net interest income suggest that the banking system remains robust. Mulberry stated that while there is a reassuring strength in the sector, prolonged high-interest rates could lead to increased stress for consumers.