With interest rates reaching their highest levels in over 20 years and inflation continuing to affect consumers, major banks are gearing up for increased risks associated with their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all boosted their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks set aside to handle potential losses stemming from credit risks, including overdue debts and commercial real estate 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 to $21.8 billion by the end of the quarter, significantly increasing its reserves from the prior quarter. Meanwhile, Wells Fargo reported $1.24 billion in provisions.
This accumulation of reserves signals that banks are preparing for a riskier lending environment, where both secured and unsecured loans may lead to larger losses for some of the nation’s largest financial institutions. A recent study by the New York Federal Reserve indicated that Americans owe a total of $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card issuance is on the rise, and delinquency rates are climbing as many people deplete their pandemic-era savings and turn increasingly to 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 cardholder balances exceeded the trillion-dollar threshold. Additionally, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the situation: “We’re still navigating the aftermath of the COVID era, particularly in relation to both banking and consumer health, which was significantly influenced by the stimulus provided to consumers.”
However, any challenges for banks are expected to materialize in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted, “The provisions observed in any quarter do not necessarily represent the credit quality over the last three months; they are indicative of what banks anticipate happening in the future.”
He emphasized the shift in focus from conventional practices, where increasing loan defaults prompted higher provisions, to a system where macroeconomic forecasts heavily influence provisioning strategies.
In the near future, banks anticipate slower economic growth, rising unemployment, and two interest rate cuts expected later in the year in September and December, which could lead to more delinquencies and defaults as 2023 comes to a close.
Citi’s chief financial officer Mark Mason highlighted concerns regarding lower-income consumers who have seen their savings diminish since the pandemic. “While we still observe an overall resilient U.S. consumer, we are noticing a performance divergence across different income levels,” Mason stated during a recent analyst call.
He pointed out that only the highest-income households reported having more savings than at the beginning of 2019, with these households driving growth in spending and maintaining high payment rates. Conversely, those with lower credit scores are experiencing declining payment rates, as they are more severely impacted by high inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% while awaiting signs of inflation stabilizing towards its 2% target before proceeding with anticipated rate cuts.
Despite banks bracing for an increase in defaults later this year, Mulberry stated that defaults are not currently rising at a level that suggests an impending consumer crisis. He is monitoring the situation closely, particularly the differences in financial stress between homeowners and renters who faced varying economic conditions during the pandemic.
While interest rates have risen sharply since that time, Mulberry noted that homeowners locked in low fixed rates on their debts and may not be feeling the financial strain as severely as renters. “Rent prices have surged more than 30% nationwide between 2019 and 2023, along with a 25% increase in grocery costs, creating significant stress for renters who did not secure low rates,” he explained.
At this juncture, the emerging narrative from the latest earnings reports is that there were no new concerns regarding asset quality this quarter. Strong revenues, profits, and robust net interest income reflect a resilient banking sector.
“There is strength within the banking industry that perhaps wasn’t entirely unexpected, but it is reassuring to confirm that the financial system remains strong and sound at this point,” Mulberry concluded. “However, the longer high interest rates persist, the greater stress it could impose.”