As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks associated with their lending activities.
In the second quarter, leading banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo escalated their provisions for credit losses compared to the previous quarter. These provisions represent the reserve funds that banks allocate to mitigate potential losses arising from credit risks, which encompass overdue payments and high-risk lending, including commercial real estate loans.
Specifically, JPMorgan set aside $3.05 billion for credit losses; Bank of America allocated $1.5 billion; Citigroup’s credit loss allowance surged to $21.8 billion by the end of the quarter, more than tripling its previous credit reserve; and Wells Fargo reported provisions of $1.24 billion.
The increased reserves reflect the banks’ anticipation of a more challenging economic landscape, where both secured and unsecured loans might lead to larger losses for some of the largest financial institutions. An analysis from the New York Fed highlighted that U.S. households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
There has also been a notable rise in credit card issuance and delinquency rates, as individuals deplete their savings from the pandemic era and increasingly rely on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter where total cardholder debt surpassed the trillion-dollar threshold, based on data from TransUnion. Additionally, the commercial real estate sector faces its own challenges.
“We’re still emerging from the COVID era, especially concerning banking and consumer health, which was largely supported by stimulus measures,” commented Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, experts suggest that the real issues for banks may soon emerge.
“The reserves reported in any quarter do not necessarily reflect credit quality from the preceding months but are instead based on banks’ expectations for the future,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He added, “It’s intriguing because we have shifted from a system where rising loan defaults triggered increased provisions to one where macroeconomic forecasts heavily influence provisioning decisions.”
Looking ahead, banks anticipate slowing economic growth, an increasing unemployment rate, and potential interest rate cuts later in the year. This may lead to more delinquencies and defaults as 2023 progresses.
Citi’s CFO Mark Mason highlighted that these warning signs are predominantly seen among lower-income consumers, who have experienced significant declines in savings since the pandemic.
“While the overall U.S. consumer remains resilient, we observe varying performances across different income and credit score segments,” Mason stated during a recent analyst call.
He noted that only the highest income quartile has retained more savings than at the beginning of 2019, with those possessing FICO scores over 740 driving spending growth and maintaining high payment rates. Conversely, lower FICO score consumers are witnessing sharper declines in payment rates and are increasing borrowing due to heightened inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% while awaiting stabilization in inflation towards the central bank’s 2% target before potentially implementing anticipated rate cuts.
Despite banks preparing for a rise in defaults as the year progresses, current default rates do not indicate an impending consumer crisis, according to Mulberry. He is particularly focused on the distinction between homeowners and renters during the pandemic.
“While rates have surged since then, homeowners secured low fixed rates, and as such, they are not experiencing the same level of financial strain,” Mulberry pointed out. “In contrast, renters missed out on that opportunity.”
With rental prices rising over 30% nationwide from 2019 to 2023 and grocery costs increasing by 25% during the same time frame, renters without low fixed rates are under the most pressure in their month-to-month budgets.
Nevertheless, the primary takeaway from the recent earnings reports is that there have been no significant changes in asset quality this quarter. Strong revenues, profits, and sustained net interest income are promising indicators of a healthy banking sector.
“There’s still a degree of strength within the banking sector that may not have been completely anticipated, but it’s reassuring to see that the financial system remains robust,” Mulberry concluded. “However, we are closely monitoring the situation, as prolonged high interest rates could introduce further stress.”