With interest rates at their highest in over 20 years and inflation persisting, major banks are bracing for increased challenges stemming from their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo each raised their credit loss provisions compared to the previous quarter. These provisions represent funds set aside to mitigate potential losses from credit risks, including overdue or uncollectible debts and lending, particularly in commercial real estate.
JPMorgan increased its credit loss provision by $3.05 billion in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, marking a significant increase from the previous quarter, and Wells Fargo contributed $1.24 billion to its provisions.
These increases underscore that banks are preparing for a more challenging environment, anticipating larger losses from both secured and unsecured loans. A recent study by the New York Federal Reserve revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, rising credit card issuance and delinquency rates are evident as individuals deplete their savings accumulated during the pandemic and turn to credit. Current credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where the total surpassed $1 trillion, according to TransUnion. The commercial real estate sector also remains in a vulnerable state.
Experts like Brian Mulberry from Zacks Investment Management note that the financial landscape is still recovering from the COVID-19 pandemic, affected significantly by government stimulus measures provided to consumers.
However, the challenges for banks are anticipated in the coming months. Mark Narron from Fitch Ratings explains that quarterly provisions do not merely illustrate recent credit quality, but rather reflect banks’ expectations for future conditions.
The banking sector is bracing for an economic slowdown, a potential rise in unemployment, and anticipated interest rate cuts later this year, which could lead to increased delinquency and default rates.
Citi’s CFO Mark Mason pointed out that potential issues seem to be more pronounced among lower-income consumers, whose savings have diminished since the pandemic.
He commented, “While we continue to see an overall resilient U.S. consumer, we also continue to see a divergence in performance and behavior across FICO and income band.” Data indicates that only the highest income quartile has retained more savings than it had in early 2019, with those possessing a credit score above 740 leading in spending and maintaining payment rates. Conversely, consumers with lower credit scores are experiencing higher borrowing rates and declining payment rates, largely due to the pressures of rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year peak between 5.25% and 5.5%, awaiting inflation to stabilize toward its 2% target before adopting the anticipated rate cuts.
Despite banks preparing for increased defaults in the latter half of the year, defaults have not yet escalated to a level indicating a consumer crisis, as noted by Mulberry. He observes a notable distinction between homeowners and renters during this period. While homeowners secured low fixed rates, renters face significantly increased living costs.
Between 2019 and 2023, rents surged over 30% nationwide, and grocery prices rose by 25%, leaving renters, who were unable to secure favorable rates, under significant financial pressure.
Overall, the most important takeaway from the recent earnings reports is that there were no significant new concerns regarding asset quality. Strong revenues, profits, and resilient net interest income remain encouraging signs for the health of the banking sector.
Mulberry expressed a sense of reassurance regarding the robustness of the financial system amidst ongoing stress, but he cautioned that protracted high interest rates could elevate pressures on consumers and the banking framework.