As interest rates reach levels not seen in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks in their lending operations.
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 funds that financial institutions allocate to cover potential losses from credit risks, including past-due debts and lending issues, particularly in commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by quarter’s end, marking a more than threefold increase from the prior quarter, and Wells Fargo designated $1.24 billion for this purpose.
These increased provisions indicate that banks are preparing for a more challenging environment in which both secured and unsecured loans may lead to larger losses. A recent analysis from the New York Fed showed that American households carry a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as people exhaust their pandemic-era savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter in which total cardholder balances surpassed the trillion-dollar mark, according to TransUnion. Additionally, the commercial real estate sector remains under significant pressure.
“We’re still emerging from the COVID era, especially in terms of banking and consumer health, which has been largely influenced by the stimulus provided to consumers,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any challenges for banks are expected in the upcoming months.
“The provisions reported each quarter don’t strictly reflect credit quality for the past three months; they indicate banks’ future expectations,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group. “Interestingly, we have shifted from a historical model where bad loans prompted increased provisions to one where macroeconomic forecasts drive provisioning levels.”
In the short term, banks anticipate slowing economic growth, rising unemployment, and two interest rate cuts later this year in September and December, which could lead to more delinquencies and defaults as the year ends.
Citi’s chief financial officer, Mark Mason, observed that these warning signs are particularly evident among lower-income consumers, who have seen their savings dwindle since the pandemic. “While the U.S. consumer remains resilient overall, we see a divergence in performance and behavior across income levels and credit scores,” he remarked in a call with analysts.
Mason noted that only the highest income quartile has more savings than they did at the start of 2019, with high FICO score customers driving spending growth and maintaining strong payment rates. In contrast, those with lower FICO scores are experiencing a decline in payment rates and are borrowing more, being more heavily affected by high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation measures toward the central bank’s 2% target before implementing expected rate cuts.
Despite banks preparing for increased defaults in the latter half of the year, current default rates do not indicate a looming consumer crisis, according to Mulberry. He is particularly observing the differences between homeowners and renters during the pandemic.
“While rates have surged since then, homeowners secured low fixed rates on their debt, so they are not feeling the same financial strain,” Mulberry noted. “Renters, however, have missed this opportunity.”
With rents increasing over 30% nationally between 2019 and 2023 and grocery prices rising by 25% in the same time frame, renters who did not secure low rates are facing significant pressures on their monthly budgets.
Currently, the primary takeaway from the latest earnings reports is that “there were no new concerns this quarter regarding asset quality,” according to Narron. Robust revenues, profits, and resilient net interest income are all signs of a still-healthy banking sector.
“There’s a level of strength in the banking sector that may not have been entirely anticipated, but it is reassuring to know that the financial system remains robust and stable,” Mulberry concluded. “However, the longer interest rates remain elevated, the more stress they are likely to cause.”