With interest rates at their highest levels in over 20 years and inflation weighing on 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 reserve to address potential losses from credit risks, which include delinquent loans and bad debts, particularly in sectors like commercial real estate.
JPMorgan set aside $3.05 billion for credit losses in the second quarter; Bank of America allocated $1.5 billion; Citigroup’s credit loss allowance amounted to $21.8 billion, more than tripling its previous quarter’s reserve; and Wells Fargo’s provisions were $1.24 billion.
These increased reserve allocations indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans may result in greater losses. A recent study by the New York Fed revealed that American households owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, credit card issuance and delinquency rates are on the rise as individuals exhaust their pandemic savings and rely more heavily on credit. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where the total exceeded the trillion-dollar threshold, according to TransUnion. Meanwhile, commercial real estate continues to face uncertainties.
“We are still emerging from the COVID period, especially concerning banking and consumer health, largely due to the stimulus provided to consumers,” said Brian Mulberry, a portfolio manager at Zacks Investment Management.
However, banks may face challenges in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that the provisions observed in any given quarter do not necessarily indicate the prevailing credit quality but rather reflect banks’ expectations for the future.
“The dynamic has shifted from a situation where increasing loan defaults led to higher provisions to one where macroeconomic forecasts drive provisioning decisions,” Narron explained.
Currently, banks anticipate slower economic growth, higher unemployment rates, and potential interest rate cuts later this year. This could result in an uptick in delinquencies and defaults by year-end.
Citi’s CFO, Mark Mason, highlighted that emerging concerns are particularly concentrated among lower-income consumers, who have seen their savings dwindle since the pandemic began.
“While we still see a resilient overall U.S. consumer, we are also observing variances in performance across different income levels,” Mason noted. “Among our consumers, only the highest income quartile has more savings now compared to early 2019, with customers having high credit scores driving spending growth and maintaining strong payment rates. Consumers with lower scores are experiencing sharper declines in payment behavior and are borrowing more due to the burden of high inflation and interest rates.”
The Federal Reserve has maintained interest rates between 5.25% and 5.5%, the highest levels in 23 years, while waiting for inflation measures to align with its 2% target before proceeding with any rate cuts.
Despite banks preparing for increased defaults in the latter half of the year, current default rates do not indicate an imminent consumer crisis, according to Mulberry. He is monitoring the differences between homeowners and renters from the pandemic era.
“Although rates have risen significantly, homeowners benefitted from locking in low fixed rates, so they are not feeling the strain as much,” Mulberry stated. “Renters, however, missed out on that opportunity.”
With average rents rising over 30% nationally between 2019 and 2023 and grocery prices increasing by 25% during the same timeframe, renters who did not secure low rates and are facing soaring rental costs are experiencing significant strain on their budgets.
For now, the most notable observation from the recent earnings reports is that there have been no major surprises regarding asset quality. According to Narron, strong revenues, profits, and resilient net interest income all point to a generally healthy banking sector.
“There is some resilience in the banking sector, which may not have been entirely unexpected, but it is reassuring to see that the financial system’s structure remains strong,” Mulberry remarked. “However, we are monitoring the situation closely, as prolonged high interest rates could introduce more stress.”