As interest rates soar to levels not seen in over 20 years and inflation continues to pressure consumers, major banks are bracing for increased risks linked to their lending practices.
During the second quarter, prominent banks including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions represent funds set aside to absorb potential losses from credit risks, such as defaults on loans and delinquencies, particularly in the commercial real estate sector.
Specifically, JPMorgan allocated $3.05 billion for credit losses, Bank of America set aside $1.5 billion, Citigroup’s allowance for credit losses reached $21.8 billion—more than a threefold increase from the prior quarter—and Wells Fargo indicated provisions of $1.24 billion.
This accumulation indicates that banks are preparing for a more challenging environment where both secured and unsecured loans may lead to significant losses. According to a recent assessment from the New York Fed, American households currently hold an astounding $17.7 trillion in various types of consumer debt, including loans and mortgages.
Rising credit card issuance and delinquency rates signal increased reliance on credit as consumers deplete their pandemic-era savings. In the first quarter, total credit card balances climbed to $1.02 trillion, marking the second consecutive quarter of exceeding the trillion-dollar threshold, as reported by TransUnion. Additionally, the commercial real estate sector remains vulnerable.
“We’re still recovering from the COVID era, and the consumer banking landscape has been significantly affected by the stimulus measures implemented during the pandemic,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, potential issues for banks are anticipated to manifest in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that the reported provisions for each quarter do not accurately reflect current credit quality but are instead indicative of future expectations.
“It’s interesting to observe that we’ve transitioned from a system in which rising delinquencies would lead to increased provisions, to one where macroeconomic forecasts play a crucial role in determining those provisions,” Narron explained.
Banks are forecasting a slowdown in economic growth, a rise in unemployment, and two anticipated interest rate cuts later this year, which could lead to more delinquencies and defaults as the year ends.
Citi’s CFO Mark Mason highlighted that these warning signs are particularly evident among lower-income consumers, who have experienced a decline in savings in recent years.
“While the U.S. consumer overall remains resilient, there is a noticeable divergence in performance and behavior based on income and credit scores,” Mason mentioned during a recent analyst call. “Only the highest income quartile has maintained more savings compared to the start of 2019, and it is customers with credit scores above 740 who are driving spending growth and high payment rates. In contrast, those with lower credit scores are seeing worrying drops in payment rates and are increasingly reliant on credit due to the impact of rising inflation.”
The Federal Reserve has maintained interest rates in the range of 5.25% to 5.5%, the highest in 23 years, awaiting stabilization in inflation metrics towards its target of 2% before implementing anticipated rate cuts.
Despite banks preparing for increased defaults in the latter half of the year, Mulberry noted that defaults are not currently escalating to a level that signals a consumer crisis. He is particularly attentive to the differences between homeowners and renters during the pandemic.
“While rates have significantly increased, homeowners have locked in low fixed rates on their debts and are not feeling the financial strain as much. Renters, however, who have faced more than 30% increases in rent and a 25% rise in grocery costs since 2019, are experiencing greater budget pressures,” Mulberry reported.
Currently, the major takeaway from the latest earnings reports is that there has been no significant change in asset quality. Strong revenues and profits, along with solid net interest income, indicate a resilient banking sector.
“There is strength within the banking sector that may not have been entirely expected, which is reassuring because the financial system’s foundation remains robust,” Mulberry concluded. However, he cautioned that prolonged high interest rates could introduce additional stress.