As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks associated with their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions represent funds that financial institutions allocate to cover potential losses from credit risks, which include delinquent accounts and loans, including those in the commercial real estate (CRE) sector.
JPMorgan set aside $3.05 billion for credit losses in the second quarter; Bank of America allocated $1.5 billion; Citigroup’s total allowance for credit losses reached $21.8 billion at the end of the quarter, more than tripling its reserves from the previous quarter; and Wells Fargo recorded provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier financial environment where both secured and unsecured loans may lead to greater losses for some of the largest banks in the nation. A recent analysis from the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
As pandemic-era savings dwindle, credit card borrowing has risen, along with delinquency rates. Credit card balances exceeded $1 trillion for the second consecutive quarter, according to TransUnion. Furthermore, commercial real estate remains under significant strain.
“We’re still transitioning from the COVID era, and the health of consumers is largely tied to the stimulus that was provided,” noted Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, potential issues for banks may emerge in the coming months.
“The provisions reported each quarter do not solely reflect credit quality from the past three months; they represent banks’ forecasts for the future,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He added, “Historically, increased loan defaults would lead to higher provisions, but now the macroeconomic outlook primarily influences these decisions.”
Looking ahead, banks are forecasting slower economic growth, a rise in unemployment, and anticipated interest rate cuts in September and December, which could lead to more delinquencies and defaults as the year concludes.
Citigroup’s Chief Financial Officer Mark Mason pointed out that warning signs seem to be particularly significant among lower-income consumers, who have experienced a decline in their savings since the pandemic began.
“While we still see a robust U.S. consumer overall, we observe a significant divergence in performance based on income and credit scores,” Mason stated during a recent analyst call.
He added, “Only those in the highest income tier have more savings now than they did in early 2019, and it’s primarily the customers with FICO scores over 740 who are maintaining spending growth and high payment rates. Conversely, those with lower FICO scores are facing declining payment rates and are borrowing more due to the impacts of high inflation and interest rates.”
The Federal Reserve has maintained interest rates at a range of 5.25% to 5.5% for 23 years, awaiting stabilization of inflation towards the central bank’s 2% target before making the expected interest rate cuts.
Despite the banks’ preparations for potential defaults later this year, Mulberry asserts that defaults have not yet escalated to levels indicative of a consumer crisis. He is particularly observing the financial situations of homeowners versus renters.
“While rates have increased significantly, homeowners secured low fixed rates on their loans and are not feeling substantial financial strain,” Mulberry commented. “In contrast, renters who were unable to lock in low rates are facing challenges.”
With rents increasing by over 30% nationwide and grocery prices rising by 25% from 2019 to 2023, renters without fixed-rate options are experiencing intensified financial pressure, as noted by Mulberry.
Ultimately, the latest earnings report highlights that “there was nothing new this quarter regarding asset quality,” according to Narron. Strong revenues, profits, and healthy net interest income signal a solid banking sector.
“There are positive indicators within the banking sector that were not entirely unexpected, but it is reassuring to see the financial system’s structures remain strong and sound,” Mulberry concluded. “However, the prolonged period of elevated interest rates will continue to create stress.”