With interest rates at their highest levels in over two decades and inflation continuing to impact consumers, major banks are preparing for increased risks linked to 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 funds allocated by banks to cover potential losses from credit risks, such as bad debt and delinquent loans, particularly in the commercial real estate sector.
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, marking more than a threefold increase from the previous quarter. Wells Fargo’s provisions stood at $1.24 billion.
These increased provisions indicate that banks are preparing for a riskier lending environment, with both secured and unsecured loans posing potential challenges. A recent study from the New York Fed highlighted that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Rising credit card issuance and delinquency rates are emerging as consumers deplete savings accumulated during the pandemic and turn increasingly to credit. According to TransUnion, credit card balances hit $1.02 trillion in the first quarter, representing the second consecutive quarter where total credit card debt surpassed the trillion-dollar mark. The commercial real estate market continues to face uncertainties as well.
Brian Mulberry, a portfolio manager at Zacks Investment Management, suggested that the banking sector is still emerging from the COVID-19 pandemic, mentioning that government stimulus played a significant role in consumer spending during this period.
Issues for banks may arise in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that quarterly provisions do not necessarily indicate recent credit quality but rather reflect banks’ expectations for the future.
Currently, banks foresee slowing economic growth, a rising unemployment rate, and anticipate interest rate cuts later this year. This may lead to a higher number of delinquencies and defaults as the year progresses.
Citi’s CFO Mark Mason pointed out that the risk signals are particularly pronounced among lower-income consumers, who have experienced dwindling savings since the pandemic.
While the overall U.S. consumer remains resilient, there exists a marked difference in financial behavior across income strata. Mason noted that only the highest income quartile had increased savings since early 2019. Those with higher credit scores are driving spending and maintaining consistent payment rates, whereas lower credit score individuals are experiencing declines in payment rates and are borrowing more as they are significantly affected by high inflation and interest rates.
The Federal Reserve has maintained interest rates at a range of 5.25% to 5.5%, holding steady until inflation levels move closer to the bank’s target of 2%.
Despite banks gearing up for potential increases in defaults in the latter part of the year, the current default rates are not yet indicative of a consumer crisis, according to Mulberry. He is particularly focused on the difference in financial stability between homeowners and renters during this time.
Even though rates have escalated, homeowners locked in lower fixed rates on their debts, allowing them to avoid significant financial strain. In contrast, renters have faced increasing rental prices, which have surged over 30% from 2019 to 2023, coupled with a 25% rise in grocery costs, leading to more significant stress on their budgets.
Nonetheless, the latest earnings reports suggest that the banking sector remains in a stable condition. Narron noted that there were no major surprises regarding asset quality this quarter. Strong revenues, profits, and robust net interest income are all positive signs of enduring health within the banking system.
Mulberry emphasized the overall strength of the financial system, noting that while the banking sector’s health is reassuring, the long-term impact of sustained high interest rates could introduce further stress into the market.