As interest rates reach their highest levels in over two decades, and inflation continues to burden consumers, major banks are bracing for increased risks in their lending operations.
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 the funds financial institutions set aside to accommodate potential losses from credit risks, including unpaid debts and loans, particularly in commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s allowance for credit losses reached $21.8 billion, more than tripling its reserves from the prior quarter; and Wells Fargo provisioned $1.24 billion.
These increased provisions indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans may lead to larger losses. A recent analysis from the New York Fed reported that Americans collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Moreover, the issuance of credit cards and delinquency rates are rising as consumers deplete their pandemic-era savings and increasingly rely on credit. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where total balances surpassed the trillion-dollar threshold. The situation in the CRE sector remains concerning.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the economy is still recovering from the COVID-19 period, driven largely by the stimulus provided to consumers.
Challenges for banks are expected to mount in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported each quarter do not solely reflect past credit quality but are based on banks’ future expectations.
He emphasized that the dynamics have shifted from a system that reacts to poor loan performance to one where macroeconomic forecasts significantly influence provisioning strategies.
In the short term, banks are anticipating slower economic growth, higher unemployment rates, and projected interest rate cuts in September and December. These factors may lead to increased delinquencies and defaults as the year concludes.
Citi’s chief financial officer Mark Mason highlighted that these concerns predominantly affect lower-income consumers, whose savings have diminished since the pandemic.
“While we continue to see an overall resilient U.S. consumer, we also observe a divergence in performance across different income groups,” Mason stated. He noted that only the top income quartile has more savings than at the start of 2019, and that customers with FICO scores above 740 are primarily driving spending growth and maintaining high payment rates. In contrast, those with lower scores are experiencing significant declines in payment rates and turning to borrowing, heavily impacted by high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting signs of stabilization in inflation before enacting the anticipated rate cuts.
Despite banks bracing for possible defaults in the latter portion of the year, Mulberry indicated that defaults have not yet risen to levels indicative of a consumer crisis. He noted a critical distinction between homeowners and renters during the pandemic era.
While interest rates have climbed sharply, homeowners benefited from locking in low fixed rates, minimizing their financial strain. Conversely, renters, who lacked this opportunity, are now facing significant financial pressure due to a more than 30% increase in nationwide rents from 2019 to 2023, coupled with a 25% rise in grocery costs over the same period.
Currently, the key takeaway from the latest earnings reports is that there were no new concerns regarding asset quality. Strong revenues, profits, and solid net interest income suggest that the banking sector remains robust.
According to Mulberry, “The banking sector demonstrates strengths that may not have been entirely anticipated, providing reassurance that our financial system’s structures remain sound. However, we continue to monitor the situation closely, as prolonged high-interest rates will inevitably lead to more stress.”