With interest rates reaching over two-decade highs and inflation putting pressure on consumers, major banks are preparing for potential risks related to their lending activities.
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 by banks to cover potential losses from credit risks, including bad debts and delinquent loans.
JPMorgan allocated $3.05 billion for credit losses during the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, more than tripling its reserve build from the previous quarter. Wells Fargo reported provisions totaling $1.24 billion.
These reserves indicate that banks are bracing for a riskier lending environment, where both secured and unsecured loans could result in greater losses. A recent analysis of household debt by the New York Federal Reserve revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
With an increase in credit card issuance, delinquency rates are also rising as people exhaust their pandemic-related savings and increasingly rely on credit. Credit card balances climbed to $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total credit card balances exceeded the trillion-dollar threshold, according to TransUnion. Additionally, commercial real estate (CRE) remains under pressure.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector and consumer health have been heavily influenced by stimulus measures provided during the COVID pandemic.
However, challenges for banks may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported each quarter do not necessarily reflect the recent credit quality but rather banks’ expectations for the future.
He added that the banking system has shifted from a model where provisions increased after loans went bad to one where macroeconomic forecasts drive provisioning decisions.
In the short term, banks anticipate slower economic growth, a rising unemployment rate, and projected interest rate cuts later this year. This could lead to increased delinquencies and defaults as 2023 progresses.
Citigroup’s chief financial officer, Mark Mason, highlighted that the risks seem to be concentrated among lower-income consumers, who have seen their savings decline since the pandemic.
Mason pointed out that while the overall U.S. consumer remains resilient, disparities exist in performance based on income and credit scores. “Only the highest income quartile has more savings than they did at the beginning of 2019,” he stated.
The Federal Reserve continues to maintain interest rates at a 23-year high of 5.25-5.5% while awaiting a stabilization of inflation toward its 2% target before proceeding with anticipated rate cuts.
Even though banks are preparing for more defaults, current rates of default do not yet indicate a full-blown consumer crisis. Mulberry continues to monitor the differences between homeowners and renters, noting that homeowners, who locked in low fixed rates, are not feeling the same financial strain as renters facing skyrocketing rental prices.
Between 2019 and 2023, rents increased over 30% nationwide, while grocery costs rose by 25%. Renters unable to secure low rates are experiencing significant stress on their budgets.
Overall, the latest earnings reports suggest stability in asset quality, with strong revenues and profits indicating a resilient banking sector. Mulberry emphasizes that despite the apparent strength, banks must remain vigilant as higher interest rates persist, which could lead to additional stress in the near future.