With interest rates reaching levels not seen in over 20 years and inflation impacting consumers, major banks are bracing for potential risks tied to their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside to cover expected losses from credit risk, which includes issues with delinquent debts and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses rose to $21.8 billion, significantly increasing from the previous quarter, and Wells Fargo recorded provisions of $1.24 billion.
The increased provisions indicate that banks are preparing for a challenging environment where both secured and unsecured loans may lead to larger losses. According to recent analysis from the New York Fed, Americans currently owe a combined total of $17.7 trillion in consumer loans, student loans, and mortgages.
There has also been a rise in credit card issuance and delinquency rates as individuals deplete their pandemic-era savings and increasingly depend on credit. In the first quarter of this year, total credit card balances hit $1.02 trillion, marking the second consecutive quarter where the total exceeded this mark, as reported by TransUnion. Additionally, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector’s situation is still evolving in the aftermath of the pandemic, largely influenced by the stimulus measures aimed at bolstering consumer finances.
Experts caution that challenges for banks could emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that provisioning levels do not reflect past credit quality but rather banks’ expectations for future economic conditions.
In the near future, banks predict a slowdown in economic growth, an increase in unemployment rates, and two anticipated interest rate cuts later this year. These factors could lead to higher delinquencies and defaults as the year progresses.
Citigroup’s CFO Mark Mason highlighted that signs of distress are particularly concentrated among lower-income consumers, who have seen their savings diminish in the years following the pandemic.
Despite an overall resilient U.S. consumer base, Mason noted a divergence in financial behavior across different income levels and credit scores. Only the wealthiest quarter have maintained higher savings compared to early 2019, with consumers who have a FICO score of over 740 driving growth in spending and keeping up with payments. Conversely, those with lower FICO scores are facing declining payment rates and increased borrowing due to the pressures of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation rates closer to its 2% target before proceeding with anticipated rate cuts.
While banks are gearing up for an increase in defaults, current rates of defaults do not yet indicate a widespread consumer crisis, according to Mulberry. He pointed out that homeowners during the pandemic enjoyed low fixed-rate mortgages and are not feeling the financial strain as much as renters.
Renters have faced significant challenges, with nationwide rents rising over 30% from 2019 to 2023, while grocery prices climbed by 25%, placing them under greater financial stress compared to those who secured low rates on mortgages.
Despite these concerns, the most recent earnings reports highlight that there were no new issues regarding asset quality. The banking sector continues to show strong revenues and profits, alongside resilient net interest income, indicating its overall health.
Narron concluded that despite the persistent high interest rates, the financial system remains robust, although growing pressure may arise the longer these rates stay elevated.