With interest rates at their highest in over two decades and inflation impacting consumers, major banks are bracing for increased risks related to their lending activities.
In the second quarter of the year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions serve as a financial cushion that institutions set aside to address potential losses stemming from credit risks, including non-repaying 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 reached $21.8 billion by the end of the quarter, more than tripling its reserves from the previous period; Wells Fargo put aside $1.24 billion for potential losses.
These increased reserves reflect the banks’ preparedness for a climate where both secured and unsecured loans could lead to greater losses. A recent study by the New York Federal Reserve revealed that Americans currently owe a staggering $17.7 trillion across various types of consumer debts, including student loans and mortgages.
As pandemic-era savings diminish, credit card usage is on the rise, leading to increasing delinquency rates. According to TransUnion, credit card balances hit $1.02 trillion in the first quarter, marking a second consecutive quarter where total balances topped the trillion-dollar mark. Additionally, commercial real estate is facing significant challenges.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the situation stems from the aftermath of the COVID-19 pandemic, spurred by extensive stimulus measures aimed at consumers.
Experts indicate that any emerging issues for banks will unfold in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported in any given quarter do not necessarily mirror recent credit quality; rather, they represent banks’ future expectations.
Interestingly, the current environment has shifted from a traditional model—where deteriorating loan performance triggered an increase in provisions—to one dominated by macroeconomic forecasts that significantly influence provisioning strategies.
In the short term, banks are forecasting slower economic growth, rising unemployment rates, and potential interest rate cuts later in the year, which could lead to increased delinquencies and defaults.
Citi’s chief financial officer, Mark Mason, highlighted that the early warning signals are most pronounced among lower-income consumers, who have seen their savings decline since the pandemic.
He noted that while the overall U.S. consumer remains resilient, there is a noticeable disparity based on income levels and credit scores. Only consumers in the upper income bracket have managed to save more than they did pre-2019, with those boasting high credit scores driving spending growth and maintaining strong payment rates. Conversely, lower credit score customers are experiencing significant decreases in payment behavior and increasing reliance on credit amid high inflation and interest rates.
The Federal Reserve has maintained interest rates at a two-decade high of 5.25 to 5.5%, awaiting stabilization of inflation towards its 2% goal before implementing any anticipated rate cuts.
Despite preparations for increased defaults later in the year, Mulberry asserts that current default rates do not suggest a consumer crisis. He is particularly focused on the divide between homeowners who benefited from low fixed rates during the pandemic and renters who did not.
While interest rates have risen, homeowners locked in lower rates on their debt, affecting the cost of living differently compared to renters who have faced dramatic increases in rental prices, which have surged over 30% from 2019 to 2023, along with a 25% rise in grocery costs during the same timeframe.
As of now, the latest earnings results indicate no significant surprises regarding asset quality. Continual solid revenues, profits, and robust net interest income suggest a still-robust banking sector. Mulberry expressed a sense of relief that the financial system remains sound despite ongoing high-interest rates, though he stressed the importance of vigilance as prolonged high rates can induce more strain.