As interest rates remain at levels not seen in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks stemming from their lending activities.
In the second quarter, four of the largest U.S. banks—JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo—reported an increase in their provisions for credit losses compared to the previous quarter. These provisions are funds set aside to cover potential losses from credit risk, which includes delinquent loans and commercial real estate (CRE) lending.
JPMorgan allocated $3.05 billion for credit losses in 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, more than tripling its reserves from the previous quarter. Wells Fargo’s provisions amounted to $1.24 billion.
The increased reserves indicate that banks are preparing for a potentially riskier lending environment, where both secured and unsecured loans may result in greater losses. A recent analysis by the New York Fed highlighted that American households now carry a collective debt of $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card usage is also on the rise, with delinquency rates climbing as consumers exhaust their savings accrued during the pandemic. In the first quarter of this year, credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. The state of commercial real estate remains uncertain as well.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking sector is still navigating the repercussions of the COVID era, largely due to the economic stimulus provided to consumers.
However, challenges for banks are anticipated in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions don’t necessarily mirror recent credit quality but rather reflect banks’ expectations for the future.
“Historically, when loans started to default, provisions would increase, but now macroeconomic forecasts have a stronger influence on provisioning,” Narron noted.
In the short term, banks are anticipating slower economic growth, higher unemployment, and potential interest rate cuts in September and December. These factors could lead to an uptick in delinquencies and defaults as the year concludes.
Citigroup’s CFO, Mark Mason, pointed out that warning signs are primarily observed among lower-income consumers who have seen their savings diminish since the pandemic.
“While the overall U.S. consumer shows resilience, there’s a noticeable divergence in performance and behavior across different income and credit score categories,” Mason stated during a recent call with analysts. He added that only the highest income quartile has increased savings since early 2019, with those having over a 740 FICO score driving spending growth.
The Federal Reserve maintains interest rates at a 23-year high between 5.25% and 5.5%, pausing for inflation to approach its 2% goal before implementing anticipated cuts.
Despite preparations for potential defaults later in the year, Mulberry observed that delinquency rates have not yet surged to levels indicative of a consumer crisis. He notes a distinction between homeowners, who secured low fixed-rate mortgages during the pandemic, and renters, who are now facing higher costs without the benefits of locked-in rates.
Between 2019 and 2023, national rents surged over 30%, and grocery prices rose by 25%, placing significant strain on renters’ budgets who have not benefited from low fixed rates.
Overall, the latest earnings reports reveal no new concerns regarding asset quality, according to Narron. The banking sector is still showing strong revenues, profits, and robust net interest income, suggesting it remains healthy.
Mulberry concluded, “The banking sector shows resilience. However, sustained high interest rates could increase financial stress over time.”