As interest rates reach their highest level in over two decades and inflation continues to impact consumers, major banks are gearing up for increased risks in their lending operations.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all raised their credit loss provisions compared to the previous quarter. These provisions are funds that banks allocate to cover potential losses from credit risks, which include bad debt and lending to sectors like commercial real estate.
JPMorgan set aside $3.05 billion for credit losses, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses climbed to $21.8 billion, a significant increase from the previous quarter, and Wells Fargo made provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier environment, as both secured and unsecured loans may lead to greater losses. An analysis from the New York Fed found that American households collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Furthermore, credit card issuance and delinquency rates are on the rise as individuals deplete their savings accumulated during the pandemic and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter, marking the second consecutive quarter where total balances surpassed the trillion-dollar mark, as reported by TransUnion. The commercial real estate sector remains uncertain as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted the lingering effects of the COVID-19 era, particularly concerning banking and consumer health, which were heavily influenced by government stimulus.
Challenges for banks may become evident in the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, explained that current provisions do not necessarily reflect past credit quality but are based on future expectations.
He highlighted a shift from traditional banks’ practices, where increased loan defaults would lead to higher provisions, to a current system where macroeconomic forecasts largely dictate banking provisions.
Looking ahead, banks anticipate slowing economic growth, rising unemployment, and potential interest rate cuts in September and December, all of which could lead to more delinquencies and defaults as the year ends.
Citi’s chief financial officer, Mark Mason, pointed out that warning signs are especially present among lower-income consumers, who have seen their savings decline post-pandemic.
“While the overall U.S. consumer remains resilient, there is a noticeable divergence in performance across income brackets and credit scores,” he stated in a conference call with analysts. He added that only the top income quartile has increased savings since early 2019, while lower-income consumers are experiencing declines in payment rates and are borrowing more due to hardships caused by high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, waiting for inflation metrics to stabilize around the central bank’s 2% target before implementing expected rate cuts.
Despite banks anticipating more defaults in the latter half of the year, Mulberry reassures that current default rates do not suggest an imminent consumer crisis. He notes a distinction between homeowners and renters, stating that although interest rates have risen significantly, many homeowners secured low fixed rates during the pandemic, allowing them to avoid immediate financial strain.
In contrast, renters who could not lock in those rates are facing mounting pressures as rental costs have surged over 30% nationally from 2019 to 2023, alongside a 25% increase in grocery prices during the same timeframe, resulting in significant stress on their budgets.
Overall, the recent earnings reports have not revealed any major new issues regarding asset quality, according to Narron. He emphasizes that the banking sector is exhibiting strong revenues, profits, and healthy net interest income.
Mulberry adds that while the banking system currently exhibits resilience and strength, the prolonged period of high interest rates could eventually lead to increased stress in the financial system.