As interest rates remain at their highest in more than two decades and inflation continues to impact consumers, major banks are preparing to confront 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 represent the funds set aside by financial institutions to cover potential losses from credit risks, including defaulted or delinquent debts and loans, like commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit loss provisions during the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, significantly amplifying its reserves from the previous quarter, and Wells Fargo’s provisions totaled $1.24 billion.
These increased provisions illustrate that banks are bracing for a more challenging environment, where both secured and unsecured loans might result in more significant losses. A recent study by the New York Federal Reserve revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
The rising issuance of credit cards, coupled with increasing delinquency rates, signals that many consumers are tapping into credit as their pandemic-era savings dwindle. In the first quarter of this year, total credit card balances reached $1.02 trillion, marking the second consecutive quarter that combined cardholder balances surpassed the trillion-dollar threshold, as reported by TransUnion. The situation in the CRE sector also remains tenuous.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, said, “We’re still coming out of this COVID era, particularly regarding banking and consumer health, and it was driven by all the stimulus provided to consumers.”
However, potential challenges for banks are anticipated in the months ahead.
Mark Narron, a senior director within Fitch Ratings’ Financial Institutions Group, explained that the provisions recorded in any quarter do not necessarily reflect the credit quality over the past three months; rather, they indicate banks’ expectations for future trends.
He noted a shift from a historical approach where provisions increased as loans defaulted, to a current scenario where macroeconomic forecasts primarily influence provisioning.
In the immediate future, banks expect slower economic growth, a rise in unemployment, and two interest rate cuts later this year, which could lead to more delinquencies and defaults as the year concludes.
Citi’s chief financial officer Mark Mason highlighted that warning signs appear to be focused on lower-income consumers, who have experienced a depletion of savings since the pandemic.
“While we continue to see an overall resilient U.S. consumer, we also observe a divergence in performance and behavior across different income and credit score bands,” Mason stated during a recent analyst call.
He pointed out that only the highest income quartile has managed to maintain more savings compared to the beginning of 2019, with those having FICO scores above 740 driving spending growth and consistently high payment rates. Conversely, lower FICO band consumers are experiencing more significant declines in payment rates and persistent borrowing due to their increased vulnerability to high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stability in inflation towards its 2% target before implementing anticipated rate cuts.
Despite banks bracing for potential defaults in the latter half of the year, Mulberry observed that defaults are not currently rising at a rate indicative of a consumer crisis. He noted key differences between homeowners and renters during the pandemic.
“Yes, rates have increased significantly, but homeowners locked in very low fixed rates on their debt, so they aren’t feeling the strain as acutely,” Mulberry remarked, contrasting this with renters who missed these opportunities.
With national rents soaring over 30% between 2019 and 2023 and grocery prices increasing by 25% in that same timeframe, renters—who did not secure low rates—are facing substantial pressure on their monthly budgets.
For the time being, the most significant takeaway from this quarter’s earnings reports is that “nothing new emerged regarding asset quality,” according to Narron. In fact, strong revenues, profits, and resilient net interest income serve as positive signals for a still-robust banking sector.
“There’s a certain strength in the banking industry that might not have been entirely unexpected, but it is indeed reassuring to note that the foundations of the financial system remain solid,” Mulberry added. “However, we are observing the situation closely, as prolonged high-interest rates are likely to induce additional stress.”