As interest rates remain at their highest levels in over twenty years and inflation continues to put pressure on consumers, major banks are gearing up to navigate the potential risks linked to their lending activities.
In the second quarter, significant banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds that financial institutions reserve for anticipated losses from credit risks, including bad debt and commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter; Bank of America reserved $1.5 billion; Citigroup’s allowance reached $21.8 billion by the end of the quarter, marking a significant increase from the prior quarter; and Wells Fargo allocated $1.24 billion.
These heightened reserves reflect banks’ readiness for a riskier lending environment that could see higher losses from both secured and unsecured loans. A recent analysis from the New York Federal Reserve revealed that U.S. households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also escalating, as individuals deplete their pandemic savings and increasingly depend on credit. In the first quarter of this year, credit card balances soared to $1.02 trillion, marking the second consecutive quarter in which total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector is also navigating a challenging landscape.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted, “We’re still coming out of this COVID era, especially regarding banking and consumer health, which was heavily supported by stimulus measures.”
Nevertheless, any banking challenges are anticipated to emerge in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that the provisions noted in any quarter do not solely reflect recent credit quality but rather indicate banks’ expectations for future developments.
He pointed out the shift in how loan performance affects provisioning, stating, “Historically, provisions would increase as loans began to falter, but now the macroeconomic outlook plays a significant role in driving provisioning.”
Banks are currently anticipating sluggish economic growth, rising unemployment, and expected interest rate cuts in September and December. This could indicate a rise in delinquencies and defaults toward the end of the year.
Citi’s chief financial officer Mark Mason highlighted that troubling trends are largely impacting lower-income consumers, whose savings have diminished in the post-pandemic period. He remarked, “While the U.S. consumer shows overall resilience, we notice a notable divergence in performance across different income levels and credit scores.”
Mason noted that only consumers in the highest income quartile have seen their savings increase since early 2019, with those holding scores over 740 driving spending growth and maintaining high payment rates. In contrast, customers with lower credit scores are experiencing a sharp decline in payment rates and are borrowing more, significantly affected by rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a two-decade high of 5.25-5.5%, awaiting stabilization of inflation towards the central bank’s target of 2% before considering rate cuts.
Despite banks preparing for further defaults later this year, Mulberry indicated that current default rates do not suggest an imminent consumer crisis. He is particularly monitoring the differences between homeowners from the pandemic era and renters.
While acknowledging the significant rise in interest rates, Mulberry said many homeowners benefited from locking in low fixed rates, alleviating immediate financial pressure. Conversely, renters, who did not have that opportunity, face significant challenges with rents soaring over 30% nationally from 2019 to 2023, alongside rising grocery costs.
Overall, the recent earnings reports reveal no new issues regarding asset quality. Strong revenues, profits, and consistent net interest income serve as positive indicators for a resilient banking sector. Mulberry concluded, “There’s substantial strength in the banking system, which is reassuring, but we must remain vigilant as prolonged high interest rates will likely induce more stress.”