As interest rates remain at their highest levels in over 20 years and inflation continues to pressure consumers, major banks are preparing for potential risks arising from 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 that financial institutions reserve to cover expected losses from credit risks, such as delinquencies and bad debts, including commercial real estate loans.
JPMorgan added $3.05 billion to its credit loss provisions, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, marking more than a threefold increase from the last quarter, and Wells Fargo recorded provisions of $1.24 billion.
These increased provisions indicate that banks are preparing for a potentially riskier environment, where both secured and unsecured loans might lead to greater losses. According to a recent analysis by the New York Fed, Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, the issuance and delinquency rates of credit cards are on the rise as consumers deplete their pandemic-era savings and increasingly rely on credit. In the first quarter of this year, credit card balances hit $1.02 trillion, marking the second consecutive quarter where total cardholder balances exceeded this milestone, as reported by TransUnion. Additionally, commercial real estate remains in a challenging position.
“We’re still emerging from the COVID era, particularly in banking and consumer health, largely due to the stimulus measures implemented,” commented Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, banks may encounter difficulties in the upcoming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, noted that the provisions reported in any quarter do not necessarily reflect recent credit quality but rather represent banks’ future expectations.
“There has been a shift from a historical model where rising loan defaults would increase provisions to one where macroeconomic forecasts primarily influence provisioning,” Narron explained.
In the near term, banks are anticipating slower economic growth, higher unemployment rates, and potential interest rate cuts in September and December, which may lead to a rise in delinquency and default rates by year-end.
Citi’s chief financial officer, Mark Mason, highlighted that concerns about financial stability are particularly pronounced among lower-income consumers, who have experienced significant declines in savings since the pandemic.
“While we see overall resilience in the U.S. consumer, we also notice varied performance and behavior across different income levels and credit scores,” Mason stated in a recent analyst call.
He added, “Among our consumer clients, only the top income quartile has more savings than they did at the start of 2019, with high-FICO score customers driving spending growth and maintaining high payment rates. In contrast, customers with lower FICO scores are seeing declining payment rates and increased borrowing due to high inflation and interest rates.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation measures towards its 2% target before considering rate cuts.
Despite banks bracing for higher default rates in the latter half of the year, Mulberry noted that defaults are not yet at levels indicative of a consumer crisis. He is particularly monitoring the distinction between homeowners who locked in low fixed rates during the pandemic and renters who did not have that opportunity.
“Although interest rates have increased significantly, homeowners secured low fixed rates on their debts and are largely shielded from the financial strain,” Mulberry explained. “In contrast, renters who faced rising costs, with rents increasing more than 30% nationwide from 2019 to 2023 and grocery prices rising 25%, are under more financial pressure, particularly as wage growth has not kept pace.”
Ultimately, Narron emphasized that the latest round of earnings reports indicate stable asset quality, with strong revenues and net interest income suggesting a healthy banking sector. “The strength observed in the banking sector should not be overlooked; it is reassuring that the financial system remains robust and sound. However, we will continue to monitor the situation closely since prolonged high interest rates could lead to increased stress,” Mulberry concluded.