Amidst rising interest rates, which are currently at their highest levels in over two decades, and ongoing inflationary pressures impacting consumers, major banks are bracing for increased risks associated with their lending activities.
In the second quarter of the year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all reported an increase in their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks set aside to cover potential losses arising from credit risks, including non-repayable debts and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit loss provisions during the second quarter, while Bank of America set aside $1.5 billion. Citigroup reported a total of $21.8 billion in credit loss allowances, more than tripling its reserves from the prior quarter. Meanwhile, Wells Fargo established provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier operational environment, where both secured and unsecured loans could lead to higher losses for some of the largest financial institutions in the country. A recent analysis by the New York Federal Reserve found that U.S. households now owe a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, the issuance of credit cards and the associated delinquency rates have also been rising as individuals begin to exhaust their pandemic-era savings and increasingly depend on credit. As of the first quarter this year, total credit card balances reached $1.02 trillion, marking the second consecutive quarter where total cardholder balances exceeded the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also remains in a vulnerable position.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked, “We’re still emerging from the COVID era, primarily in terms of banking and consumer health. The situation was significantly influenced by the stimulus that was extended to consumers.”
However, any potential issues for banks are anticipated to manifest in the coming months.
Mark Narron, a senior director at Fitch Ratings, explained, “The reserves indicated in any quarter do not necessarily reflect credit quality for the past three months; they rather indicate what banks foresee happening in the future.”
He added that the current focus has shifted from a historical approach where rising loan defaults would lead to increased reserves, to a system where macroeconomic predictions primarily influence provisioning.
Looking ahead, banks are forecasting a slowdown in economic growth, higher unemployment rates, and potential interest rate cuts scheduled for September and December of this year. These factors could result in a rise in delinquencies and defaults as the year comes to a close.
Citi’s chief financial officer, Mark Mason, highlighted concerning trends among lower income consumers, noting that their financial situations have worsened since the pandemic as their savings dwindle.
“While the overall U.S. consumer remains resilient, we are noticing varied performance and behavior across different segments based on income levels,” Mason stated in a recent analyst call. “Currently, only the highest income quartile has more savings than they did at the start of 2019, primarily supported by consumers with FICO scores over 740 who drive spending growth and maintain high payment rates. In contrast, consumers with lower FICO scores are experiencing increases in borrowing and noticeable declines in payment rates due to the impact of high inflation and rising interest rates.”
The Federal Reserve has maintained interest rates within the range of 5.25-5.5%, the highest rate seen in 23 years, as it awaits stabilization in inflation measures to approach its target of 2% before implementing anticipated rate cuts.
Despite banks preparing for potential increases in defaults during the latter half of the year, current default rates have not yet shown signs indicative of a broader consumer crisis, according to Mulberry. He is observing the differences between individuals who became homeowners during the pandemic and those who rented.
“Although interest rates have risen significantly since that time, homeowners have secured low fixed rates on their debts, making them less vulnerable to financial stress,” Mulberry noted. “Conversely, renters missed out on such opportunities.”
Amidst a national surge in rents exceeding 30% from 2019 to 2023, along with grocery costs surging 25% during the same period, renters are facing heightened financial strain as rental prices continue to outpace wage increases.
Despite these challenges, the key takeaway from the recent earnings reports is that there have been no significant negative developments concerning asset quality, according to Narron. Strong revenues, profitability, and resilient net interest incomes are all promising indicators for a banking sector that remains largely healthy.
Mulberry concluded, “Some resilience in the banking sector persists, which might not have been entirely unexpected, but it comes as a relief to affirm that the financial system’s foundations remain robust and sound. However, we are observant, as prolonged elevated interest rates will likely induce further stress.”