As interest rates reach their highest levels in over 20 years and inflation continues to impact consumers, major banks are bracing for potential risks in their lending operations.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside to cover potential losses from credit risks, including issues with delinquent or bad debts, especially in areas like commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses rose significantly to $21.8 billion, more than tripling its reserves from the previous quarter, and Wells Fargo had provisions amounting to $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans could lead to greater losses. A recent report from the New York Fed highlighted that U.S. consumers currently owe a total of $17.7 trillion across various forms of loans, including consumer debt, student loans, and mortgages.
The rate of credit card issuance and the associated delinquency rates are also rising as individuals exhaust their pandemic savings and increasingly rely on credit. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total balances exceeded the trillion-dollar mark. Additionally, the commercial real estate sector remains under considerable strain.
“As we emerge from the COVID era, the banking sector is still influenced by the stimulus provided to consumers,” noted Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Experts believe that significant challenges for banks may arise in the near future. “The provisions reported in any given quarter do not always reflect the credit quality of the past three months; they instead indicate what banks anticipate for the future,” explained Mark Narron, a senior director at Fitch Ratings.
He added that the industry has shifted from a model where rising loan defaults prompted higher provisions to one where macroeconomic forecasts drive provisioning decisions.
Currently, banks foresee slower economic growth, a rise in the unemployment rate, and two expected interest rate cuts later this year, which may lead to increased delinquencies and defaults as the year concludes.
Citi’s Chief Financial Officer Mark Mason emphasized that the warning signs are predominantly seen among lower-income consumers, who have experienced a decline in savings since the pandemic began. “While the overall U.S. consumer remains resilient, a discrepancy is evident in performance across different income levels,” he stated.
Mason also observed that only the highest income quartile has accumulated more savings compared to 2019, and consumers with FICO scores above 740 are contributing to spending growth and maintaining high payment rates. In contrast, customers with lower credit scores are experiencing a decline in their payment rates and are borrowing more as they face the pressures of inflation and rising interest rates.
The Federal Reserve is maintaining interest rates at a 23-year high of 5.25-5.5%, waiting for inflation to stabilize at the central bank’s target of 2% before moving forward with anticipated rate cuts.
Despite banks preparing for an increase in defaults later in the year, experts like Mulberry note that current default rates do not yet indicate a consumer crisis. He highlights the distinction between homeowners and renters, pointing out that while interest rates have surged, many homeowners have locked in low fixed rates and are not feeling the same financial strain. Conversely, renters, who did not benefit from low mortgage rates, are struggling with increased rents, which have risen over 30% nationwide from 2019 to 2023, alongside a 25% increase in grocery costs.
Overall, the latest earnings reports suggest that there have been no significant changes in asset quality this quarter. Positive indicators of strong revenues, profits, and robust net interest income suggest that the banking sector remains in good health. Mulberry remarked that while the banking sector displays strength, there should be continued vigilance, as prolonged high interest rates could lead to increased stress in the industry.