With interest rates more than two decades high and inflation impacting consumers, major banks are bracing for increased risks in their lending activities.
In the second quarter of the year, 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 set aside by financial institutions to cover potential losses stemming from credit risks such as bad debts and lending related to commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s credit loss allowance reached $21.8 billion by the quarter’s end, tripling its reserves from the prior quarter. Wells Fargo’s provisions amounted to $1.24 billion.
The increase in provisions suggests banks are preparing for a more challenging lending environment, where both secured and unsecured loans may lead to significant losses. A recent study from the New York Fed indicated that American households collectively owe $17.7 trillion on various types of loans, including consumer, student, and mortgage debts.
Credit card usage and delinquency rates are also on the rise as individuals deplete their pandemic savings and increasingly rely on credit. According to TransUnion, total credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter in which cardholder balances surpassed the trillion-dollar threshold. Additionally, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted the ongoing impact of the COVID era, particularly regarding consumer health influenced by stimulus measures.
Challenges for the banks are anticipated in the coming months. Mark Narron, a senior director at Fitch Ratings, emphasized that quarterly provisions reflect banks’ future expectations rather than past credit quality.
Currently, banks foresee a slowdown in economic growth, a rise in unemployment, and potential rate cuts in September and December, which may lead to more delinquencies and defaults as the year progresses.
Citi’s chief financial officer, Mark Mason, pointed out that the warning signs are largely affecting lower-income consumers, who have seen their savings diminish since the pandemic.
Despite resilient consumer behavior overall, Mason highlighted a disparity based on income and FICO scores. Only the highest income quartile has managed to save more compared to early 2019, with higher credit score customers driving spending growth, while lower-scoring consumers are experiencing decreased payment rates and escalating borrowing due to high inflation rates.
The Federal Reserve is maintaining interest rates at a 23-year peak of 5.25-5.5%, awaiting stabilization of inflation toward its 2% target before implementing anticipated rate cuts.
While banks are preparing for potential defaults later in the year, Mulberry stated that defaults have not yet escalated to a level suggesting a consumer crisis. He emphasized the distinction between homeowners and renters during the pandemic; homeowners secured low fixed rates, alleviating some of the financial pressure, unlike renters who have faced significant rent increases.
Rents have surged over 30% nationwide from 2019 to 2023, with grocery prices rising by 25%, adding to the financial burden for renters grappling with rising costs that exceed wage growth.
However, the latest earnings reports indicate no significant changes in asset quality, with strong revenues and profits signaling a stable banking sector.
Mulberry remarked on the current resilience in the banking industry, indicating that while the situation is stable now, sustained high interest rates could eventually lead to increased stress.