As interest rates climb to levels not seen in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks associated with their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all raised their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks allocate to cover potential losses stemming from credit risks, including delinquent debt and various kinds of loans, such as commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America increased its provisions to $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, more than tripling from the previous period, and Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging economic landscape, where both secured and unsecured loans may lead to greater losses. A recent report from the New York Fed highlighted that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as consumers deplete their pandemic-era savings and rely increasingly on credit. Credit card debt reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total card balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also remains precarious.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the ongoing recovery from the COVID-19 pandemic and the impact of governmental stimulus on consumer behavior.
However, challenges for banks may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, pointed out that the provisions that banks report do not always reflect past credit quality but instead indicate their expectations for future conditions.
He noted a shift from the previous norm where provisions increased in response to deteriorating loans to a model where macroeconomic forecasts play a significant role in provisioning.
Banks are currently anticipating slowing economic growth, an increase in unemployment rates, and potential interest rate cuts in September and December. These factors could lead to more delinquencies and defaults by year’s end.
Citi’s chief financial officer, Mark Mason, highlighted that warning signs are primarily evident among lower-income consumers, who have seen a decline in their savings since the pandemic.
Despite an overall resilient U.S. consumer base, there are disparities in performance and behavior along income lines. Mason noted that only the highest-income quartile has more savings compared to early 2019, while borrowers with lower credit scores are experiencing not only a decrease in payment rates but also increasing borrowing as they face higher inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25% to 5.5%, awaiting stabilization of inflation towards the target of 2% before implementing anticipated rate cuts.
While banks are preparing for an uptick in defaults later this year, Mulberry indicates that current default rates do not yet suggest a looming consumer crisis. He draws a contrast between homeowners, who secured low fixed rates on their debts during the pandemic, and renters, who are under more financial pressure due to rising rental costs.
Rent prices have surged over 30% nationwide from 2019 to 2023, and grocery costs have increased by 25%, putting significant strain on renters’ budgets, particularly against stagnant wage growth.
Despite these concerns, the latest earnings reports revealed no significant deterioration in asset quality. Commentators have pointed to strong revenue, profits, and resilient net interest income as signs of a healthy banking sector.
Overall, there remains a measure of strength within the banking system, but observers caution that prolonged high interest rates could lead to further financial stress.