As interest rates remain at levels not seen in over 20 years, and inflation continues to impact consumers, major banks are bracing for increased risks associated with their lending activities.
In the second quarter, leading financial institutions including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their provisions for credit losses compared to the previous quarter. These provisions are funds set aside to address potential credit risks, such as defaults on loans, including commercial real estate (CRE) financing.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s credit loss allowance jumped to $21.8 billion by the end of the quarter, more than tripling the previous quarter’s reserve. Wells Fargo’s provisions reached $1.24 billion.
This increase in reserves indicates that banks are preparing for a potentially more challenging environment, with the risk of both secured and unsecured loans leading to larger losses. According to a recent report from the New York Fed, the total household debt in the U.S. stands at $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card issuance is also on the rise, along with delinquency rates, as many consumers deplete the savings accrued during the pandemic and increasingly depend on credit. Credit card debt reached $1.02 trillion in the first quarter, marking the second consecutive quarter where totals exceeded $1 trillion, as reported by TransUnion. The outlook for CRE remains uncertain as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted the ongoing repercussions of the COVID era on banks and consumer health, largely due to the stimulus measures implemented to support consumers.
Challenges for banks are expected in the months to come. Mark Narron, a senior director at Fitch Ratings, explained that current provisions do not strictly reflect recent credit quality but rather the banks’ expectations for future trends.
He highlighted that, historically, provisions would increase when loans began to perform poorly, but the current economic outlook significantly influences provisioning decisions.
In the short term, banks anticipate a slowdown in economic growth, higher unemployment rates, and two scheduled interest rate cuts later in the year, potentially leading to increased delinquencies and defaults by year-end.
Citigroup CFO Mark Mason pointed out that signs of financial strain seem particularly evident among lower-income consumers, who have seen their savings diminish since the pandemic began.
“While the overall U.S. consumer appears resilient, there is a noticeable divergence in performance among various income brackets,” Mason said in a recent analyst call. He added that only the top income quartile has maintained higher savings since early 2019, with high FICO score customers driving spending growth. In contrast, those with lower credit scores are experiencing declining payment rates and greater reliance on credit amidst high inflation and interest rates.
The Federal Reserve’s current interest rate is held at a 23-year high of 5.25-5.5%, as officials await stabilization of inflation towards the central bank’s target of 2% before implementing anticipated rate cuts.
Despite banks preparing for a higher wave of defaults later in the year, Mulberry noted that current default rates do not suggest an imminent consumer crisis. He is observing the differences between homeowners and renters from the pandemic period. Homeowners, who locked in low fixed-rate mortgages, are largely unaffected, while renters face increased costs.
With national rents surging over 30% and grocery prices rising 25% from 2019 to 2023, renters without low-rate leases are under significant financial pressure.
For now, analysts concluded that recent earnings reports indicate stability in asset quality, with positive revenues, profits, and robust net interest income reflecting a resilient banking sector.
“While some strength in the banking sector was not entirely unexpected, it’s reassuring to know that the financial system remains robust,” Mulberry stated. “However, we remain vigilant, as prolonged high interest rates could lead to increased stress in the future.”