With interest rates reaching over two-decade highs and inflation continuing to affect consumers, major banks are bracing for potential risks associated with their lending activities.
In the second quarter, major banks, including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo, increased their provisions for credit losses compared to the previous quarter. These provisions serve as a financial buffer against potential losses from credit risks, encompassing issues like delinquent debts and commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, more than tripling its reserve compared to the previous quarter, and Wells Fargo’s provisions amounted to $1.24 billion.
These increases indicate that banks are preparing for a more hazardous lending environment, where both secured and unsecured loans may lead to increased losses for these financial institutions. A recent survey from the New York Fed highlighted that Americans collectively owe $17.7 trillion in various consumer loans, student loans, and mortgages.
Credit card usage and delinquency rates are also on the rise as many individuals deplete their pandemic-era savings and increasingly rely on credit. Credit card balances climbed to $1.02 trillion in the first quarter of the year, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector remains particularly vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked, “We are still emerging from the COVID era, particularly in banking and consumer health, much of it due to the stimulus provided to consumers.”
However, banks are likely to encounter challenges in the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, explained that the provisions reported by banks for any given quarter don’t necessarily reflect past credit quality but rather what banks forecast for the future.
Narron noted that banks anticipate a slowdown in economic growth, an uptick in unemployment rates, and the possibility of two interest rate cuts later this year. This scenario may lead to more delinquencies and defaults as the year progresses.
Citi’s chief financial officer, Mark Mason, pointed out that the signs of trouble are particularly evident among lower-income consumers, who have seen their savings diminish since the pandemic began.
“While we observe overall resilience in the U.S. consumer, we also notice a disparity in performance based on FICO scores and income levels,” Mason stated during a recent analyst call. He added that only the highest income quartile has managed to retain more savings than they had at the start of 2019, with those having over a 740 FICO score driving growth and maintaining high payment rates. Conversely, lower FICO band customers are experiencing significant declines in payment rates and are borrowing more due to the challenges posed by high inflation and interest rates.
The Federal Reserve has maintained its interest rates at a 23-year high of 5.25-5.5%, awaiting inflation to settle towards its 2% target before implementing expected rate cuts.
Despite banks preparing for a potential rise in defaults in the later part of the year, current data does not indicate that defaults are escalating to a level suggesting a consumer crisis, Mulberry noted. He is particularly observing the distinction between homeowners and renters from the pandemic period.
Mulberry explained that despite substantial rate increases, homeowners who locked in low fixed rates on their debts are not feeling the financial strain as acutely, unlike renters who have faced significant rent increases without similar protections.
Rent costs surged by over 30% nationwide between 2019 and 2023, and grocery prices rose by 25% during the same timeframe. Renters, who missed out on low-rate opportunities, are experiencing the most financial pressure on their monthly budgets.
Overall, the latest earnings reports indicate no significant changes in asset quality. Narron stated that robust revenues, profits, and strong net interest income are positive signs for the banking sector’s health.
Mulberry concluded, “There remains strength in the banking sector, which is reassuring. However, we are closely monitoring the situation, as prolonged high interest rates can introduce additional stress.”