With interest rates at their highest levels in over 20 years and inflation continuing to pressure consumers, major banks are bracing themselves for increased risks related to 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 allocate to cover potential losses stemming from credit risks, such as delinquent payments or bad debt, which includes loans for commercial real estate.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s total allowance for credit losses reached $21.8 billion by the end of the quarter, marking a substantial increase from the prior period. Wells Fargo also recorded $1.24 billion in provisions.
These increased reserves indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans may result in greater losses. A recent report from the New York Federal Reserve revealed that American households hold a combined $17.7 trillion in consumer loans, student debt, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as consumers begin to exhaust their pandemic-era savings and increasingly depend on credit. In the first quarter of this year, total credit card balances reached $1.02 trillion, marking the second consecutive quarter where balances exceeded the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also remains in a vulnerable state.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the effects of the COVID era, especially regarding banking and consumer health, were largely influenced by stimulus measures provided to consumers.
However, any challenges facing the banks are anticipated to manifest in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported by banks are not necessarily indicative of immediate credit quality but rather reflect future expectations.
As banks forecast slower economic growth, an uptick in unemployment, and two potential interest rate cuts later this year in September and December, they anticipate increased delinquencies and defaults as the year progresses.
Citi’s chief financial officer, Mark Mason, highlighted that issues appear to be concentrated among lower-income consumers who have seen their savings diminish since the pandemic. He remarked that while the overall U.S. consumer landscape remains resilient, there is a marked disparity in performance based on income levels and credit scores.
Mason noted that only the highest income quartile has managed to increase their savings since early 2019, and those in the over-740 FICO score bracket are driving spending growth and maintaining high payment rates. In contrast, individuals with lower credit scores are experiencing significant drops in payment rates and increasingly rely on borrowing, heavily impacted by rising inflation and interest rates.
The Federal Reserve has kept interest rates at a 23-year high of 5.25-5.5%, awaiting signs of stabilization in inflation towards the central bank’s 2% goal before considering anticipated rate cuts.
Despite banks bracing for more defaults later in the year, Mulberry emphasized that current default rates do not signal an impending consumer crisis. He highlighted the differences between homeowners and renters during the pandemic, noting homeowners benefited from low fixed rates, while renters faced significant increases in rent since then.
With rents increasing over 30% nationwide between 2019 and 2023 and grocery costs rising by 25%, renters who did not secure low rates are experiencing higher financial stress.
For now, the latest earnings reports indicate that there are no unexpected developments in asset quality within the banking sector. Strong revenues, profits, and robust net interest income are encouraging signs of ongoing stability.
Mulberry stated, “There’s some strength in the banking sector that I don’t know was totally unexpected, but it’s certainly a relief to see that the structures of the financial system are still very strong.” He cautioned, however, that prolonged high interest rates could introduce more pressure in the future.