Amid record-high interest rates and persistent inflation, major banks are readying themselves for increased risks associated with their lending operations.
In the second quarter, leading financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their provisions for credit losses compared to the previous quarter. These provisions refer to the funds banks allocate to cover potential credit-related losses, which can arise from factors like delinquent payments and problematic loans, particularly in commercial real estate.
JPMorgan set aside $3.05 billion in provisions for credit losses, while Bank of America provided $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the quarter’s close, a figure that more than tripled from the previous quarter. Wells Fargo established $1.24 billion in provisions.
The increase in these reserves indicates that banks are preparing for a more dangerous lending environment, as both secured and unsecured loans may result in larger losses. A New York Fed analysis reported that Americans collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
As pandemic-era savings deplete, credit card use—and delinquency rates—are also climbing. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter that total balances exceeded the trillion-dollar threshold, according to TransUnion. Moreover, commercial real estate continues to be in a vulnerable state.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that we are still emerging from the COVID era which saw a plethora of stimulus funds directed to consumers.
However, challenges for banks are anticipated in the upcoming months. Mark Narron, a senior director at Fitch Ratings, indicated that the provisions reported by banks do not merely reflect recent credit quality but are indicative of future expectations.
He noted a shift from a historical approach where rising loan defaults prompted increased provisions to a system where macroeconomic forecasts guide these provisions.
Banks are currently forecasting slowing economic growth, a potential increase in the unemployment rate, and anticipated interest rate cuts in September and December. These factors could lead to increased delinquencies and defaults by the year’s end.
Citi’s chief financial officer, Mark Mason, highlighted that warning signs seem most prevalent among lower-income consumers, who have seen their savings deplete significantly since the pandemic.
“While we see an overall resilient U.S. consumer, there is a noticeable difference in performance across various income levels and credit scores,” Mason explained in a recent analyst call. He pointed out that only the highest income quartile holds more savings than they did at the start of 2019, with those in higher credit score brackets contributing to spending growth while maintaining high payment rates. In contrast, customers with lower credit scores are experiencing declines in payment rates and are increasingly borrowing, as they are more severely affected by rising inflation and interest rates.
The Federal Reserve has held interest rates at 5.25-5.5%, the highest level in 23 years, awaiting stabilization in inflation rates before instituting anticipated cuts.
Despite banks’ preparations for an uptick in defaults, Mulberry noted that defaults are not currently rising at levels indicating a consumer crisis. He is particularly attentive to the differences between homeowners and renters during the pandemic.
“While interest rates have significantly increased, homeowners secured low fixed rates on their debt, insulating them from immediate impacts. Renters did not have this opportunity,” Mulberry said.
With rents surging over 30% from 2019 to 2023 and food prices rising by 25% in the same timeframe, renters who could not secure low rates amid stagnant wage growth are feeling the most financial strain.
Overall, the recent earnings reports indicate that there have not been significant changes in asset quality, according to Narron. Strong revenues, profits, and net interest income suggest the banking sector remains resilient.
“There is robustness within the banking sector, providing reassurance about the stability of the financial system at this moment. However, we remain vigilant, as prolonged high interest rates may lead to increased pressure,” Mulberry cautioned.