With interest rates reaching their highest levels in over two decades and inflation pressing heavily 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 banks set aside to address potential losses related to credit risks, including bad debts and various lending activities, such as commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in Q2, while Bank of America set aside $1.5 billion. Citigroup reported a total allowance for credit losses of $21.8 billion at the quarter’s close, which more than tripled from the previous quarter. Wells Fargo had provisions amounting to $1.24 billion.
These increased provisions indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans could lead to elevated losses for some of the largest financial institutions in the country. An analysis by the New York Fed revealed that Americans currently owe about $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise as individuals start to deplete their pandemic-era savings and increasingly turn to credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter where total cardholder balances exceeded the trillion-dollar threshold, according to TransUnion. Additionally, the commercial real estate sector remains in a precarious situation.
“We’re still emerging from this COVID era, and particularly regarding banking and consumer health, stimulus measures had a significant impact,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any difficulties for the banks may unfold in the upcoming months.
“The provisions observed in any given quarter do not necessarily reflect credit quality over the past three months but rather indicate banks’ expectations for the future,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
“It’s notable that we have shifted from a historical model where increased loan defaults would trigger higher provisions, to a model driven significantly by macroeconomic forecasts,” he added.
In the near future, banks anticipate slower economic growth, a higher unemployment rate, and two interest rate cuts later this year, in September and December. This could result in more delinquencies and defaults as the year concludes.
Citi CFO Mark Mason pointed out that these warning signs seem to be particularly pronounced among lower-income consumers, who have seen their savings diminish since the pandemic began.
“While we continue to observe an overall resilient consumer market in the U.S., there is a noticeable divergence in performance and behavior across different income levels and credit scores,” Mason noted during an analysts’ call earlier this month.
“Among our consumer clientele, only the highest income quartile has managed to save more than at the start of 2019, and those with FICO scores above 740 are significantly contributing to spending growth and maintaining higher payment rates,” he said. “In contrast, customers with lower FICO scores are experiencing steep declines in payment rates while borrowing more, as they are more severely affected by rising inflation and interest rates.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stability in inflation measures towards the central bank’s target of 2% before implementing anticipated rate cuts.
Despite banks preparing for increased defaults in the latter part of the year, current default rates are not rising enough to suggest a looming consumer crisis, according to Mulberry. He is particularly observing the distinction between homeowners during the pandemic and renters.
“Yes, interest rates have increased significantly since then, but homeowners secured very low fixed rates on their debts, meaning they aren’t feeling as much financial strain,” Mulberry explained. “In contrast, renters missed that opportunity.”
With rents climbing over 30% nationally from 2019 to 2023, and grocery costs increasing by 25% in the same timeframe, those renting without the benefit of fixed-rate agreements are experiencing greater financial stress due to skyrocketing rental prices that have outpaced wage growth.
For now, the primary takeaway from the recent earnings reports is that “there were no surprises this quarter in terms of asset quality,” Narron stated. In fact, strong revenues, profits, and resilient net interest income are all signs of a banking sector that remains healthy.
“There’s a level of strength in the banking sector that, while not entirely unexpected, is certainly reassuring, indicating that the financial system’s structures remain robust at this time,” Mulberry concluded. “However, we are closely monitoring the situation, as prolonged high interest rates may lead to increased stress.”