With interest rates reaching their highest points in over two decades and inflation continuing to pressure consumers, major banks are preparing 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 absorb potential losses from credit risks, which can include delinquent debts and loans, such as those related to commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s allowance for credit losses reached $21.8 billion, reflecting a tripling of its reserves from the prior quarter; and Wells Fargo designated $1.24 billion for this purpose.
These increased reserves indicate that banks are anticipating a riskier lending environment, where both secured and unsecured loans might lead to significant losses. A recent analysis by the New York Federal Reserve highlighted that Americans owe a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, the rates of credit card issuance and delinquency are climbing as consumers deplete their pandemic-era savings and increasingly depend on credit. In the first quarter of this year, credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. Moreover, the commercial real estate sector remains under stress.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted, “We’re still recovering from the COVID era, particularly with banking and consumer health, stemming from the stimulus provided to consumers.”
However, any challenges for banks are expected to emerge in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that quarterly provisions do not necessarily reflect recent credit quality; rather, they are based on banks’ expectations for future conditions.
The short-term outlook for banks includes predictions of slowing economic growth, rising unemployment, and anticipated interest rate cuts in September and December, which could lead to increased loan delinquencies and defaults by year-end.
Citigroup’s chief financial officer, Mark Mason, pointed to concerns predominantly affecting lower-income consumers, who have seen their financial resources diminish since the pandemic began. He observed a split among consumers, stating that “while we see an overall resilient U.S. consumer, there is a divergence in performance among income levels and credit scores.”
Mason explained that only the highest income quartile has managed to save more than in early 2019, and customers with credit scores above 740 are the primary drivers of spending growth and consistent payment rates. In contrast, borrowers with lower credit scores are experiencing greater payment challenges while relying more heavily on credit in the face of rising inflation and interest rates.
The Federal Reserve continues to maintain interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation metrics toward its 2% target before implementing widely anticipated rate cuts.
Despite banks bracing for a potential rise in defaults in the latter half of the year, Mulberry indicates that defaults are not currently elevating at a level indicative of a consumer crisis. He highlights the differing experiences of homeowners, who generally secured low fixed-rate mortgages, and renters, who have not benefitted from such opportunities.
While interest rates have surged, homeowners remain insulated from many impacts due to their locked-in rates, unlike renters who faced rising rental prices. Nationally, rents have escalated over 30% from 2019 to 2023, while grocery costs have risen 25%, leaving renters, who have not secured low rates, feeling a strain on their budgets.
Nevertheless, recent earnings reports revealed no new concerns regarding asset quality, according to Narron. Strong revenues, profits, and robust net interest income suggest the banking sector remains healthy.
Mulberry emphasized, “There’s some strength in the banking sector that is somewhat reassuring, indicating that the structures of the financial system are still strong and sound. However, we are closely monitoring the situation, as prolonged high-interest rates cause increasing stress.”