As interest rates remain at their highest levels in over two decades and inflation continues to affect consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all reported significant increases in their provisions for credit losses compared to the previous quarter. These provisions represent funds that banks set aside to cover potential losses from credit risk, including overdue payments and bad debts, particularly in commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, more than tripling its reserves from the previous quarter, and Wells Fargo recorded provisions of $1.24 billion.
These increased provisions indicate that banks are preparing for a more volatile financial environment, where both secured and unsecured loans may lead to larger losses for these institutions. According to a recent study by the New York Fed, American households collectively owe $17.7 trillion across consumer loans, student debts, and mortgages.
Furthermore, credit card issuance is on the rise, along with delinquency rates, as consumers tap into credit due to dwindling pandemic-era savings. In the first quarter of this year, total credit card balances exceeded $1 trillion for the second consecutive quarter, according to TransUnion. The commercial real estate sector continues to face instability as well.
Brian Mulberry, a portfolio manager at Zacks Investment Management, emphasized the ongoing effects of the COVID-19 pandemic, particularly regarding banking and consumer health, which were supported by stimulus measures.
Problems for banks may become more apparent in the coming months. “The provisions that you see at any given quarter don’t necessarily reflect credit quality for the last three months; they reflect what banks expect to happen in the future,” explained Mark Narron, a senior director at Fitch Ratings.
Narron also noted the shift in provisioning methods over time, highlighting that current economic forecasts are now a primary driver of provisioning decisions rather than simply reacting to increasing loan defaults.
Banks are currently projecting slower economic growth, a rise in unemployment, and two anticipated interest rate cuts later this year in September and December, which may lead to an uptick in delinquencies and defaults.
Citi’s CFO, Mark Mason, pointed out that potential issues appear to be concentrated among lower-income consumers who have seen significant declines in their savings since the pandemic began. “While we continue to see an overall resilient U.S. consumer, we also see a divergence in performance and behavior across different income brackets,” he mentioned.
According to Mason, only the highest income quartile still has more savings now compared to the beginning of 2019. He noted that consumers with high credit scores are driving spending growth and maintaining strong payment rates, while those in lower credit score bands are struggling more significantly due to inflation and high interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it monitors inflation trends in relation to its 2% target before proceeding with any anticipated rate cuts.
Despite banks preparing for higher defaults later this year, there is no current indication of a widespread consumer crisis, according to Mulberry. He highlighted a distinction between homeowners, who secured low fixed-rate mortgages during the pandemic, and renters, who may now be facing steep rent increases.
With national rents having surged over 30% from 2019 to 2023 and grocery prices rising by 25% in the same timeframe, renters without locked-in low rates are experiencing significant stress in their budgets.
Overall, recent earnings reports have not revealed new concerns regarding asset quality. According to Narron, healthy revenues, profits, and net interest income signal a robust banking sector.
“There’s strength in the banking sector that may not have been completely anticipated, but it’s reassuring that the foundations of the financial system remain strong,” Mulberry commented. “However, we will be closely monitoring the situation; prolonged high interest rates will likely increase financial stress.”