As interest rates reach 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, 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 financial institutions set aside to mitigate potential losses from credit risk, including bad debts and various lending types, such as commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses rose to $21.8 billion at the end of the quarter, more than tripling its reserve build from the prior quarter, and Wells Fargo reported provisions of $1.24 billion.
These financial maneuvers indicate that banks are preparing for a potentially riskier landscape, where both secured and unsecured loans might lead to greater losses. A recent report from the New York Fed disclosed that American households now owe a combined $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card issuance has been on the rise, with delinquency rates following suit as many consumers exhaust their pandemic-era savings and increasingly turn to credit. As of the first quarter, total credit card balances hit $1.02 trillion, marking the second consecutive quarter that the overall balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also remains vulnerable.
“We’re still navigating the aftermath of the COVID pandemic, particularly in terms of banking and consumer health, which was significantly supported by stimulus measures,” remarked Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, the banks are anticipating challenges in the following months. “The provisions seen in any given quarter don’t necessarily reflect recent credit quality, but rather what banks expect to encounter in the future,” explained Mark Narron, a senior director at Fitch Ratings.
He noted that we have shifted from a system where rising loan defaults triggered higher provisions to one where macroeconomic forecasts heavily influence provisioning decisions. Currently, banks anticipate slower economic growth, increased unemployment, and potential interest rate cuts later this year.
Citi’s chief financial officer, Mark Mason, indicated that warning signs are becoming more pronounced among lower-income consumers, whose savings have diminished since the pandemic began. “While we observe a generally resilient U.S. consumer, disparities in performance and behavior persist across income levels,” Mason stated during a recent analyst call.
Data reveals that only the highest income quartile holds more savings than at the start of 2019, with consumers boasting FICO scores over 740 driving spending increases and maintaining good payment rates. In contrast, customers with lower FICO scores are experiencing significant drops in payment rates and are relying more on borrowing due to 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 toward the central bank’s target of 2% before implementing anticipated rate cuts.
Despite banks preparing for an increase in defaults later this year, current default rates do not suggest a crisis among consumers, according to Mulberry. He is closely observing the divide between homeowners and renters during this period.
“While rates have risen significantly, homeowners locked in low fixed rates on their debts and are less affected by current conditions,” Mulberry explained. In contrast, renters, who did not have the opportunity to secure low rates, face heightened financial stress as rents have soared over 30% nationwide since 2019, alongside a 25% rise in grocery costs.
For now, the key message from the latest earnings reports is that there have been no new concerns regarding asset quality. Strong revenues, profits, and healthy net interest income signal a robust banking sector. “There is ongoing strength in the banking sector, which is reassuring given the current financial landscape,” Mulberry concluded. “However, we continue to monitor the potential stress as interest rates remain elevated.”