Interest rates are now at their highest level in over 20 years, and as inflation continues to affect consumers, major banks are preparing for increased risks associated with their lending practices.
In the second quarter, major banks including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo reported higher provisions for credit losses compared to the previous quarter. These provisions are funds that banks set aside to account for potential losses from overdue loans and credit risks, including commercial real estate loans.
JPMorgan allocated $3.05 billion for credit loss provisions 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, marking a threefold increase from the previous quarter, and Wells Fargo reported provisions of $1.24 billion.
These increased provisions indicate that banks are preparing for a riskier financial environment where both secured and unsecured loans may lead to higher losses. According to recent data from the New York Fed, total household debt in the U.S. has reached a staggering $17.7 trillion, comprising consumer loans, student loans, and mortgages.
Credit card use is also rising, alongside increasing delinquency rates, as many consumers are depleting the savings they accumulated during the pandemic and are turning to credit for support. Credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. Additionally, the commercial real estate sector remains uncertain.
“We’re still navigating the aftermath of COVID, particularly regarding consumers’ financial health, influenced by the stimulus funds provided during the pandemic,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Much of the impact on banks may be felt in the upcoming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported quarterly do not necessarily reflect past credit quality but rather banks’ expectations for the future.
Banks project slower economic growth, a potential increase in unemployment, and anticipate two interest rate cuts in September and December. This outlook suggests that delinquencies and defaults could increase as the year progresses.
Citigroup’s chief financial officer, Mark Mason, highlighted that the risks appear particularly pronounced among lower-income consumers, who have seen a decline in their savings since the pandemic began.
“While the overall U.S. consumer remains resilient, there’s a noticeable divergence in financial performance across different income levels,” Mason explained. He noted that only the highest-income quartile has managed to retain more savings than they had in early 2019.
The Federal Reserve’s interest rates remain at a 23-year high between 5.25% and 5.5%, as they await stabilization of inflation towards the central bank’s target of 2% before implementing anticipated rate cuts.
Despite banks bracing for a potential rise in defaults, current data do not indicate a consumer crisis. Mulberry is closely monitoring the difference in financial circumstances between homeowners and renters during this period.
Homeowners managed to secure low fixed-rate mortgages, which have buffered them from current rate increases, whereas renters face significant challenges due to rising rents, which have increased by over 30% nationwide from 2019 to 2023, coupled with grocery costs that have risen by 25%.
For now, the key takeaway from the latest earnings reports is that there haven’t been any alarming changes in asset quality. Strong revenues, profits, and healthy net interest income signal that the banking sector remains robust.
Mulberry concluded that while the current strength in the banking sector is encouraging, the prolonged period of high interest rates may lead to increased financial stress over time.