As interest rates remain at their highest levels in over 20 years and inflation continues to affect consumers, major banks are bracing for increased risks from 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 are funds set aside by banks to cover potential losses from delinquent accounts and risky lending practices, including commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses, while Bank of America set aside $1.5 billion; Citigroup’s allowance reached $21.8 billion, more than tripling its reserves from the previous quarter; and Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a more volatile environment, where both secured and unsecured loans may lead to more significant losses. A recent analysis by the New York Fed revealed that U.S. consumers collectively owe $17.7 trillion in various loans, including consumer, student, and mortgage debt.
Furthermore, credit card issuance and delinquency rates are on the rise as consumers, depleted of their pandemic-era savings, increasingly rely on credit. Credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. The situation for commercial real estate also remains precarious.
Experts suggest that the impact of post-pandemic economic conditions is still unfolding. Brian Mulberry, a client portfolio manager at Zacks Investment Management, stated that the health of consumers has been significantly influenced by the stimulus measures deployed during the pandemic.
However, potential challenges for banks are likely to emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions reflect banks’ expectations about future credit quality, rather than the actual credit quality experienced in the last quarter.
In the short-term, banks are forecasting slower economic growth, rising unemployment, and anticipated interest rate cuts later this year, which could lead to an increase in delinquencies and defaults as 2023 draws to a close.
Citigroup’s CFO, Mark Mason, highlighted that the concerns appear to be concentrated among lower-income consumers, whose savings have diminished since the pandemic began. While overall consumer resilience is evident, there is a noticeable divergence in behavior based on income and credit scores.
Mason noted that only the highest income quartile has managed to retain more savings compared to early 2019, and it is mainly consumers with FICO scores over 740 that are driving growth in spending and maintaining solid payment rates. In contrast, lower-income customers are experiencing significant drops in payment rates and are borrowing more due to the pressures of high inflation and interest rates.
The Federal Reserve continues to keep interest rates at a 23-year high between 5.25% and 5.5%, waiting for inflation to stabilize towards the 2% target before implementing the expected interest rate cuts.
Despite banks preparing for an increase in defaults later in the year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He emphasizes the differing experiences between homeowners and renters during this period. Homeowners benefiting from low fixed-rate debts have not felt the same financial strain as renters, who have faced more than a 30% increase in rent prices from 2019 to 2023, along with a 25% rise in grocery costs.
Currently, the earnings reports indicate that the banking sector remains healthy, with strong revenues, profits, and net interest income. Narron noted that overall asset quality has shown no significant changes this quarter. As Mulberry pointed out, while the financial system appears robust, the ongoing high interest rates are likely to increase stress in the future.