As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks related to their lending operations.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their credit loss provisions compared to the previous quarter. These provisions represent funds set aside by banks to cover potential losses from credit risks, such as bad debt and delinquency, particularly in sectors like commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit losses during the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance reached a staggering $21.8 billion by the end of the quarter, more than tripling its reserves from the prior quarter. Wells Fargo’s provisions amounted to $1.24 billion.
The rising provisions signal a readiness among banks for a more complex and challenging lending landscape, where both secured and unsecured loans could lead to significant losses for the nation’s largest banks. Recent data from the New York Fed reveals that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Furthermore, credit card usage and delinquency rates are climbing as consumers draw down their pandemic-era savings and increasingly rely on credit. As of the first quarter of this year, credit card balances hit $1.02 trillion, marking the second consecutive quarter where totals surpassed the trillion-dollar milestone, according to TransUnion. The commercial real estate sector also faces uncertainty.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the situation, stating that the banking landscape is still recovering from the impacts of COVID-19, particularly regarding consumer health largely affected by stimulus measures.
However, challenges for banks are expected to surface in the coming months. Mark Narron from Fitch Ratings emphasized that current provisions are more indicative of banks’ future expectations rather than reflecting past credit quality.
Narron noted the banks’ outlook includes projections of slower economic growth, rising unemployment, and anticipated interest rate cuts later in the year, which may lead to more delinquencies and defaults.
Citigroup’s CFO Mark Mason highlighted that emerging concerns are mainly among lower-income consumers, who have seen significant declines in their savings since the pandemic.
“While we see an overall resilient U.S. consumer, there’s a noticeable divergence in performance and behavior across income levels,” Mason explained during a recent analyst call. “The wealthiest quartile maintains higher savings compared to early 2019, driven by high FICO score customers who continue to show spending growth and high payment rates. In contrast, lower FICO customers are facing a drop in payment rates and are borrowing more due to the impacts of high inflation and interest rates.”
The Federal Reserve has maintained interest rates at a 23-year high, holding steady at 5.25-5.5% as it waits for inflation to stabilize towards the central bank’s 2% target before implementing anticipated rate cuts.
Despite banks gearing up for potential defaults later in the year, current default rates do not yet suggest a consumer crisis, according to Mulberry. He is particularly monitoring the divide between pandemic homeowners and renters.
“Rates have increased significantly, but homeowners locked in low fixed rates, so they aren’t feeling the squeeze as much. Those who were renting during that time did not have the same opportunity,” he said.
With rent surging over 30% nationally from 2019 to 2023 and grocery prices rising 25%, renters who missed out on low rates are experiencing heightened financial strain, as indicated by Mulberry.
Overall, the latest earnings reports suggest no significant changes in asset quality, according to Narron. Strong revenues and profits, coupled with robust net interest income, reflect a still-healthy banking sector.
“There’s a resilience in the banking sector that wasn’t entirely expected, but it’s reassuring to see that the financial system’s structure remains solid and sound at this time,” Mulberry noted. “Nonetheless, we are closely monitoring the situation; prolonged high interest rates will inevitably increase stress on the system.”