With interest rates reaching their highest levels in over two decades and inflation continuing to pressure consumers, major banks are bracing themselves for increased risks associated with their lending operations.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all reported a rise in their provisions for credit losses compared to the previous quarter. These provisions represent funds that banks set aside to guard against potential losses from credit risk, including delinquent or bad debt as well as lending practices, particularly regarding commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s total allowance for credit losses soared to $21.8 billion by the end of the quarter, reflecting a significant increase from the prior quarter; and Wells Fargo reported provisions of $1.24 billion.
This accumulation of funds indicates that banks are preparing for a more uncertain environment, where both secured and unsecured loans may result in larger losses for some of the largest financial institutions in the country. A recent survey conducted by the New York Federal Reserve revealed that American households currently owe a staggering $17.7 trillion in various consumer debts, including loans and mortgages.
The issuance of credit cards and subsequent delinquency rates are also on the rise as consumers exhaust their pandemic-era savings and turn increasingly to credit. Total credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that these balances have surpassed the trillion-dollar threshold, according to TransUnion. Furthermore, the commercial real estate sector remains incredibly vulnerable.
“We are still recovering from the COVID era, particularly regarding banking and consumer health, largely due to the stimulus measures that were implemented,” noted Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any potential challenges for banks are anticipated in the coming months.
“The provisions reflected in any given quarter do not directly indicate credit quality for the last three months, but rather what banks forecast for the future,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
“It’s interesting to see the transition from a historical system where increased loan defaults triggered higher provisions, to a current climate where macroeconomic forecasts are primarily influencing provisioning,” he added.
In the near future, banks expect a slowdown in economic growth, an uptick in unemployment rates, and two anticipated interest rate cuts in September and December, as noted by Narron. This scenario could lead to higher delinquency and default rates as the year comes to an end.
Citigroup’s Chief Financial Officer, Mark Mason, highlighted that these economic warning signs seem to predominantly affect lower-income consumers, who have seen their savings diminish since the pandemic.
“While the overall U.S. consumer appears resilient, there is a noticeable divergence in performance and behavior based on FICO scores and income levels,” Mason stated during a recent analyst call.
“Among our consumer clients, only the top income quartile has maintained more savings than they held at the beginning of 2019. Those with FICO scores over 740 are driving spending growth and keeping up with high payment rates, while lower FICO score customers are experiencing significant drops in payment rates and are borrowing more, impacted severely by high inflation and interest rates.”
The Federal Reserve maintains interest rates at a 23-year high of 5.25% to 5.5% as it awaits stabilization in inflation measures towards its 2% target before implementing the anticipated rate cuts.
Despite banks gearing up for increased defaults in the latter half of the year, it has been noted that defaults are not currently rising at a level that would indicate a consumer crisis, according to Mulberry. He is particularly observing the contrast between homeowners and renters during the pandemic.
“While interest rates have risen significantly since then, homeowners locked in very low, fixed-rate debt and thus haven’t felt the pinch as much,” Mulberry explained. “In contrast, renters missed out on that opportunity.”
With rent prices surging over 30% nationally between 2019 and 2023, alongside a 25% increase in grocery costs during the same timeframe, renters who could not secure low rates are coping with financial strain that exceeds wage growth, according to Mulberry.
Currently, the key takeaway from the recent wave of earnings reports is that “there were no significant updates this quarter concerning asset quality,” Narron stated. In fact, positive indicators such as strong revenues, profits, and stable net interest income suggest a resilient banking sector overall.
“There is some strength in the banking sector that may not have been entirely expected, but it certainly offers reassurance that the financial system remains robust and sound at this time,” Mulberry concluded. “However, we need to monitor this closely, as prolonged high interest rates could induce additional stress.”