With interest rates reaching levels not seen in over two decades and inflation continuing to put pressure on consumers, major banks are taking steps to address potential risks arising from 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 that banks set aside to mitigate potential losses from credit risks, including non-performing loans and delinquencies, particularly in 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 total for credit losses reached $21.8 billion at the quarter’s close, significantly higher than the prior quarter; and Wells Fargo provisioned $1.24 billion.
The increased provisions indicate that banks are preparing for a challenging financial landscape, where both secured and unsecured loans could lead to significant losses. A recent analysis by the New York Federal Reserve reported that U.S. households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also climbing, as consumers exhaust their pandemic-era savings and turn to credit for everyday expenses. Credit card balances rose to $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where this figure surpassed the trillion-dollar threshold, according to TransUnion. Additionally, the situation in the commercial real estate sector remains uncertain.
“We’re transitioning from the COVID period, and much of the banking sector’s current health hinges on the stimulus provided to consumers,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, challenges for banks are expected to emerge in the coming months. “The provisions reported in any given quarter don’t solely reflect the credit quality from the past three months; they also indicate what banks anticipate for the future,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
“The shift has been significant, moving from a system where provisions increased in response to bad loans to one where macroeconomic forecasts heavily influence provisioning,” he added.
Currently, banks are forecasting slower economic growth, a rise in unemployment rates, and two anticipated interest rate cuts later this year. This environment could lead to an uptick in delinquencies and defaults by the year’s end.
Mark Mason, Citi’s chief financial officer, pointed out that these warning signs seem particularly concentrated among lower-income consumers, who have experienced significant reductions in savings since the pandemic.
“While we continue to observe a generally resilient U.S. consumer, disparities in performance and behavior are evident across different income levels and credit scores,” Mason noted during an analyst call. “Only the top income quartile has managed to save more than at the start of 2019, with higher FICO score clients driving spending growth and maintaining good payment rates. In contrast, lower FICO score customers are facing declines in payment rates and increased borrowing, as they are more severely affected by the impacts 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 in inflation measures towards the central bank’s 2% target prior to implementing expected rate cuts.
Although banks are bracing for increased defaults later in the year, current default rates do not suggest an immediate consumer crisis, according to Mulberry. He is particularly interested in assessing the differences between homeowners and renters during the pandemic.
“While rates have significantly increased, homeowners locked in very low fixed rates, resulting in them not feeling significant financial strain,” said Mulberry. “Conversely, renters have borne the brunt of rising costs without having the same opportunity.”
With rents growing over 30% nationwide and grocery prices surging by 25% from 2019 to 2023, renters who couldn’t secure low rates are facing greater financial challenges, according to Mulberry.
For now, the key takeaway from the recent earnings reports is that there were no significant changes in asset quality. In fact, robust revenues, profits, and a healthy net interest income suggest that the banking sector remains in a strong position.
“There is some resilience in the banking sector that was not entirely unexpected, and it’s reassuring to note that the structures of the financial system are currently stable,” Mulberry commented. “However, we are keeping a close eye on the situation, as persistent high interest rates may continue to exert pressure.”