As interest rates reach their highest levels in over two decades and inflation continues to exert pressure on consumers, major banks are gearing up to navigate increased risks associated with their lending activities.
In the second quarter, major banks including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their provisions for credit losses compared to the previous quarter. These provisions serve as a financial cushion that institutions set aside to address potential losses arising from credit risks, such as bad 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 stood at $21.8 billion at the end of the quarter, representing a more than threefold increase from the previous quarter. Wells Fargo’s provisions amounted to $1.24 billion.
The increase in provisions suggests that banks are preparing for a potentially riskier financial environment where both secured and unsecured loans could lead to greater losses. A recent report from the New York Federal Reserve indicated that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are rising as many consumers deplete their pandemic-era savings and rely more heavily on credit. By the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter in which cardholder balances exceeded the trillion-dollar threshold, according to TransUnion. Additionally, CRE remains in a vulnerable state.
“We’re still emerging from the COVID era, especially regarding banking and consumer health, which was significantly supported by government stimulus,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, experts warn that challenges for banks may emerge in the coming months. “The provisions reported in any quarter don’t necessarily reflect the credit quality of the last three months but rather what banks anticipate happening in the near future,” said Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He added, “Historically, provisions would increase when loans began to falter, but now macroeconomic forecasts heavily influence provisioning.”
In the short term, banks are bracing for slower economic growth, rising unemployment, and anticipated interest rate cuts later this year in September and December, according to Narron. This could lead to an uptick in delinquencies and defaults as the year comes to a close.
Citi’s chief financial officer, Mark Mason, noted that warning signs are primarily concentrated among lower-income consumers, who have seen their savings diminish since the pandemic. “While the overall U.S. consumer remains resilient, disparities in performance and behavior are evident across various income levels and credit scores,” Mason explained during an analyst call earlier this month.
He pointed out that only the highest income quartile has maintained higher savings compared to early 2019, with customers boasting over a 740 FICO score driving spending growth and maintaining solid payment rates. Meanwhile, those in lower FICO bands are experiencing declines in payment rates and increasing borrowing due to the impacts of inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, holding off on rate cuts until inflation stabilizes toward the central bank’s 2% target.
Despite the banks’ preparations for potential defaults later this year, Mulberry noted that defaults are not increasing at a rate indicative of a consumer crisis. He is particularly monitoring the divide between homeowners and renters during the pandemic. “While rates have surged, homeowners secured low fixed rates on their debts, so they aren’t feeling as much pressure. Renters, on the other hand, missed out on this opportunity,” Mulberry explained.
With rents rising over 30% nationwide from 2019 to 2023, along with a 25% increase in grocery costs during the same period, renters without fixed-rate protections are facing significant budgetary challenges.
Overall, the latest earnings reports suggest that there have been no significant surprises in asset quality. In fact, robust revenues, profits, and resilient net interest income point toward a healthy banking sector. “There are indicators of strength within the banking sector, which is somewhat reassuring, but we need to remain vigilant as prolonged high interest rates could lead to increased stress,” Mulberry concluded.