As interest rates reach levels not seen in over 20 years and inflation continues to impact consumers, major banks are preparing for increased risks in 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 that banks set aside to address potential losses from credit risks, including overdue debts and commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit loss provisions 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 previous quarter’s build. Wells Fargo made provisions of $1.24 billion.
This buildup indicates that banks are bracing for a potentially riskier environment, where both secured and unsecured loans could lead to significant losses. A recent analysis by the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also increasing as individuals deplete their pandemic-era savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, the second consecutive quarter where totals exceeded the trillion-dollar mark, according to TransUnion. Meanwhile, commercial real estate remains vulnerable.
“We’re still emerging from the COVID era, and when it comes to banking and consumer health, the stimulus deployed to consumers played a significant role,” said Brian Mulberry, a portfolio manager at Zacks Investment Management.
However, potential issues for banks may surface in the coming months. “The provisions seen in any quarter do not necessarily reflect credit quality over the past three months; they show what banks anticipate for the future,” said Mark Narron, senior director at Fitch Ratings’ Financial Institutions Group.
Narron noted that banks project slowing economic growth, higher unemployment rates, and possible interest rate cuts later this year. This scenario could imply an increase in delinquencies and defaults as the year closes.
Citi CFO Mark Mason pointed out that the warning signs appear particularly among lower-income consumers, who have seen their savings diminish since the pandemic. “While the overall U.S. consumer remains resilient, there’s a notable divergence in performance across income levels,” Mason stated in a recent analyst call.
According to Mason, only the highest-income quartile has more savings than before the pandemic, with those holding over a 740 FICO score driving spending growth and maintaining high payment rates. Conversely, consumers in lower FICO brackets are experiencing significant drops in payment rates and are borrowing more due to the pressures of rising inflation and interest rates.
The Federal Reserve has sustained interest rates at a 23-year high of 5.25%-5.5%, awaiting stabilization in inflation measures to meet its 2% target before implementing anticipated rate cuts.
Despite banks preparing for potential defaults later in the year, current delinquency rates do not indicate an impending consumer crisis, according to Mulberry. He is particularly monitoring the contrast between homeowners and renters from the pandemic era.
“While rates have increased significantly, homeowners secured very low fixed rates, so they are not feeling the impact as much. Renters, on the other hand, who could not benefit from such opportunities, are facing challenges,” Mulberry noted.
Rent costs have surged over 30% nationwide from 2019 to 2023, while grocery prices increased by 25% during the same period. Renters are experiencing greater financial strain as rental prices outpace wage growth.
Currently, the primary takeaway from the latest earnings reports is that “there was nothing new this quarter regarding asset quality.” In fact, robust revenues, profits, and steady net interest income point to a resilient banking sector.
“There’s a strength in the banking sector that is somewhat reassuring, signaling that the financial system remains strong and sound at this time,” Mulberry added. “However, the longer interest rates remain elevated, the more stress could arise.”