With interest rates at their highest in over 20 years and inflation continuing to impact consumers, major banks are bracing for potential risks associated with 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 are funds that banks reserve to cover possible losses from credit risks such as delinquent debt and challenging lending environments, particularly in commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, significantly raising its reserves from the previous quarter, and Wells Fargo recorded provisions totaling $1.24 billion.
These increased reserves indicate that banks are preparing for a more volatile financial landscape, where both secured and unsecured loans might lead to higher losses. A recent report from the New York Fed highlighted that U.S. consumers currently owe over $17.7 trillion in various loans, including consumer and student loans, along with mortgages.
Credit card usage is also on the rise, leading to increased delinquency rates as individuals exhaust their pandemic-era savings and turn to credit. As of the first quarter of this year, credit card balances surpassed $1 trillion for the second straight quarter, according to TransUnion. Additionally, the CRE sector remains vulnerable.
“We’re still recovering from the COVID era, particularly in banking and consumer health, largely due to the stimulus provided to consumers,” commented Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, banks anticipate that any challenges will manifest in the coming months. “The quarterly provisions reflect what banks expect to encounter in the future, rather than credit quality from the past three months,” explained Mark Narron, senior director of Fitch Ratings’ Financial Institutions Group.
He noted a shift from relying strictly on historical loan performance to using macroeconomic forecasts to guide provisioning decisions. In the near term, banks are predicting slower economic growth, increased unemployment, and potential interest rate cuts in September and December, which could result in higher rates of delinquency and defaults by year’s end.
Citigroup’s CFO Mark Mason observed that financial flags are becoming increasingly noticeable 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 is a noticeable discrepancy in performance based on credit scores and income levels,” Mason said during an analyst call. He remarked that only the highest income quartile has managed to increase their savings since early 2019, with those holding FICO scores above 740 driving spending growth and maintaining high payment rates. Conversely, those in lower FICO score bands are experiencing significant declines in payment rates and increasing borrowing, heavily impacted by inflation and rising interest rates.
The Federal Reserve has maintained interest rates between 5.25% and 5.5%, a level not seen in 23 years, as it awaits for inflation to stabilize towards the 2% target before implementing anticipated rate cuts.
Despite banks preparing for a wave of defaults later this year, current default rates do not indicate a full-blown consumer crisis, according to Mulberry. He is paying attention to the distinction between homeowners and renters stemming from the pandemic.
“Rates have increased significantly, but homeowners secured low fixed rates during that time and are not feeling as much pressure,” Mulberry stated. “Renters, however, who did not benefit from that opportunity are facing more challenges.”
Rents nationwide have surged over 30% from 2019 to 2023, and grocery prices have risen by about 25% in the same timeframe. Consequently, renters struggling with rising rental costs and stagnant wage growth are under considerable budget pressure.
Overall, analysts noted that the latest earnings reports show no alarming changes in asset quality, with robust revenues, profits, and net interest income continuing to reflect a strong banking sector.
“There is some strength in the banking sector, which might not have been entirely unexpected, but it’s reassuring that the fundamental structures of the financial system remain solid,” Mulberry commented. “Still, we need to watch closely; prolonged elevated interest rates will likely result in more strain.”