With interest rates at their highest in over two decades and inflation affecting consumers, major banks are preparing for increased risk in their lending activities.
In the recent second quarter report, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the prior quarter. These provisions are essential for covering potential losses from credit risks, including overdue or bad debts and loans, particularly in commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses; Bank of America allocated $1.5 billion; Citigroup’s credit loss reserve reached $21.8 billion, more than tripling from the previous quarter; and Wells Fargo established provisions of $1.24 billion.
These increases suggest that banks are preparing for a potentially riskier environment, where both secured and unsecured loans could lead to significant losses. According to a recent analysis by the New York Federal Reserve, Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards and corresponding delinquency rates are also rising as individuals exhaust their pandemic-era savings and increasingly rely on credit. In the first quarter, total credit card balances reached $1.02 trillion, marking the second consecutive quarter where total balances exceeded the trillion-dollar mark, as reported by TransUnion. Moreover, the situation facing CRE remains tenuous.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted, “We’re still coming out of this COVID era, especially in relation to banking and consumer health. It was largely the stimulus deployed to consumers that has shaped the current landscape.”
However, any challenges banks may encounter are expected in the upcoming months.
Mark Narron, a senior director at Fitch Ratings, explained, “The provisions seen each quarter don’t just reflect credit quality from the past three months; they indicate what banks foresee occurring in the future.”
“It’s an interesting shift, moving from a system where provisions would increase after loans began to default to one where macroeconomic forecasts significantly influence provisioning,” he added.
Looking ahead, banks anticipate slowing economic growth, rising unemployment, and potential interest rate cuts later this year, which could result in increased delinquencies and defaults by year-end.
Citi’s chief financial officer, Mark Mason, observed that warning signs appear to be particularly evident among lower-income consumers who have experienced a decline in savings since the pandemic.
“While the overall U.S. consumer remains resilient, we notice significant differences in performance across FICO scores and income levels,” Mason mentioned during a recent analyst call.
He specified, “Only the highest income quartile has more savings than at the start of 2019, and it’s the customers with over a 740 FICO score who are driving spending growth and maintaining high payment rates. Meanwhile, lower FICO customers are experiencing sharper declines in payment rates and borrowing more, impacted more heavily by high inflation and interest rates.”
The Federal Reserve has maintained interest rates between 5.25% and 5.5%, the highest levels in 23 years, pending stabilization of inflation towards the central bank’s 2% target before making anticipated rate cuts.
Despite banks bracing for potential defaults in the latter half of the year, current rates of default do not indicate an impending consumer crisis, according to Mulberry. He is particularly attentive to the distinction between those who owned homes during the pandemic and those who rented.
“Rates have increased significantly since then, but homeowners secured very low fixed rates on their debt, so they’re not feeling overwhelming pressure,” Mulberry noted. “Conversely, renters did not have that benefit.”
As rents surged over 30% nationwide from 2019 to 2023, alongside a 25% increase in grocery costs, renters—who did not benefit from low rates—are facing heightened financial strain.
For now, the most significant observation from the latest earnings reports is that “there was nothing new this quarter regarding asset quality,” Narron stated. Strong revenues, profits, and stable net interest income are promising signs for the overall health of the banking sector.
“There is a resilience in the banking sector that, while not wholly unexpected, is certainly reassuring. The foundations of the financial system remain quite strong at this moment,” Mulberry said. “Nonetheless, we are monitoring the situation closely, as prolonged high interest rates will continue to exert pressure.”