As interest rates reach their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing 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 that banks reserve to cover potential losses from credit risks, including delinquent debts and commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citi raised its allowance for credit losses to $21.8 billion by the end of the quarter, more than tripling its previous provision, and Wells Fargo made provisions totaling $1.24 billion.
These increases indicate that banks are preparing for a riskier economic landscape where both secured and unsecured loans may lead to greater losses. A recent study by the New York Fed revealed that Americans currently owe $17.7 trillion across consumer loans, student loans, and mortgages.
Additionally, credit card issuance has risen, along with delinquency rates, as consumers begin to deplete their pandemic savings and increasingly depend on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder debt exceeded the trillion-dollar threshold, according to TransUnion. The commercial real estate sector is also faced with challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector is still recovering from the COVID-19 pandemic largely due to consumer stimulus programs. However, any issues for banks may emerge in the coming months.
Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, emphasized that the credit quality reflected in quarterly provisions does not solely reflect past performance; rather, it is influenced by future expectations. He remarked on a shift in the system, where macroeconomic forecasts increasingly drive provisioning.
Looking ahead, banks are anticipating slower economic growth, a rise in unemployment, and possible interest rate cuts in September and December, which could lead to heightened delinquency and default rates by year’s end.
Citi’s CFO Mark Mason pointed out that the financial troubles seem to be concentrated among lower-income consumers, many of whom have seen their savings deplete since the pandemic. He observed that while the overall U.S. consumer remains resilient, there is a noticeable disparity in financial performance across different income and credit score groups.
Mason explained that only the highest income quartile has more savings now compared to early 2019, with those scoring above 740 on the FICO scale driving spending growth and maintaining high payment rates. Conversely, customers with lower FICO scores are experiencing significant drops in payment rates and are borrowing more due to the impacts of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year peak of 5.25% to 5.5%, waiting for stabilization in inflation towards its 2% goal before implementing anticipated rate cuts.
Despite banks gearing up for an increase in defaults later this year, Mulberry indicated that current defaults have not yet risen to alarming levels suggesting a consumer crisis. He noted that homeowners, who locked in low fixed rates during the pandemic, are less affected by rising rates compared to renters who are facing increased rental costs.
With rental prices climbing over 30% nationwide and grocery prices rising 25% from 2019 to 2023, renters—that did not secure those low rates—are experiencing more financial strain, according to Mulberry.
Currently, the latest earnings provide a reassuring outlook with no significant new issues in asset quality. Strong revenues, profits, and resilient net interest income suggest that the banking sector remains robust. Mulberry concluded by stating that while the banks show some strength, prolonged high-interest rates will contribute to increased stress in the system.