Amid high interest rates, exceeding two-decade highs, and persistent inflation affecting 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 are funds set aside by financial institutions to mitigate potential losses from credit risk, which includes delinquent loans and bad debts, particularly from commercial real estate (CRE) lending.
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 by the end of the quarter, significantly exceeding its previous reserve builds, and Wells Fargo recorded provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans may lead to greater losses. A recent report by the New York Fed estimated that Americans owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards and subsequent delinquency rates are on the rise as consumers exhaust their pandemic savings and increasingly rely on credit. Credit card debt reached $1.02 trillion in the first quarter, marking the second consecutive quarter where total cardholder balances surpassed a trillion dollars, according to TransUnion. CRE lending remains particularly vulnerable.
“We are still navigating the post-COVID environment, especially in relation to banking and consumer health, which was heavily influenced by stimulus payments,” stated Brian Mulberry, a client portfolio manager with Zacks Investment Management.
However, potential issues for banks are anticipated in the upcoming months.
“The provisions for credit losses reflect banks’ expectations of future credit quality rather than the actual condition over the past quarter,” commented Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
He noted a shift in approach, moving from a historical model where provisions rose as loan defaults increased, to one where macroeconomic forecasts heavily influence provisioning.
In the immediate future, banks are anticipating reduced economic growth, a rise in unemployment, and possible interest rate cuts later this year in September and December. These factors could lead to higher delinquency and default rates as the year concludes.
According to Citi CFO Mark Mason, the warning signs are particularly prominent among lower-income consumers, whose savings have diminished since the pandemic.
“While we observe an overall resilient U.S. consumer base, we are noting disparities in performance and behavior across different income levels and credit scores,” Mason stated during a recent earnings call.
He added that only the wealthiest quartile of consumers has managed to increase their savings since early 2019, with those holding a FICO score above 740 driving spending growth and maintaining high payment rates. In contrast, consumers with lower credit scores are experiencing significant drops in payment rates and are borrowing more due to the pressures of inflation and high interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting signs of inflation stabilizing towards the central bank’s target of 2% before proceeding with anticipated rate cuts.
Despite banks forecasting an increase in defaults in the latter half of the year, current default rates do not suggest a consumer crisis according to Mulberry. He notes a distinction between homeowners and renters from the pandemic period.
“While interest rates have increased significantly, homeowners locked in low fixed rates, so they are less affected by current conditions,” Mulberry explained. “Renters, however, did not benefit from this, facing challenges as rents have surged over 30% nationwide from 2019 to 2023.”
With rent and grocery costs rising significantly, renters are the most affected demographic struggling to balance their budgets.
For now, the latest earnings report indicates stability in asset quality without new alarming trends. Strong revenues, profits, and healthy net interest income are positive signs for the banking sector.
“There remains some fortitude in the banking system, reflecting a positive outlook,” Mulberry remarked. “However, we are closely monitoring the situation as sustained high interest rates can lead to increased stress within the sector.”