As interest rates remain at their highest levels in over 20 years and inflation continues to impact consumers, major banks are bracing for increased risks stemming 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 represent the funds banks allocate to cover potential losses due to credit risk, such as defaults on loans, including commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses, Bank of America allocated $1.5 billion, Citigroup’s allowance reached $21.8 billion, marking a significant increase from the previous quarter, while Wells Fargo designated $1.24 billion for the same purpose.
These increases indicate that banks are preparing for a more uncertain financial environment, where both secured and unsecured loans may lead to larger losses. The New York Fed recently analyzed household debt, revealing that Americans collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Additionally, credit card issuance is rising, and delinquency rates are also increasing as individuals deplete their pandemic savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total balances surpassed the trillion-dollar mark, according to TransUnion. Commercial real estate also continues to face challenges.
“We are still recovering from the COVID era, and the initial consumer health stemmed from the stimulus that was provided,” noted Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Challenges for banks may emerge in the near future. Mark Narron, a senior director at Fitch Ratings, stated that current provisions do not reflect past credit quality but rather banks’ expectations for future developments.
“We’ve transitioned to a system where macroeconomic forecasts largely influence provisioning,” he added.
In the short term, banks anticipate a slow economic growth, a rise in unemployment, and potential interest rate cuts in September and December, which could further increase delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, pointed out that financial stress appears to be more pronounced among lower-income consumers, who have seen their savings decline since the pandemic.
“Overall, the U.S. consumer remains resilient, but we observe significant variations in performance across different income and credit score levels,” Mason stated. He highlighted that only the highest income quartile has increased their savings since 2019, with higher credit score customers leading in spending growth and payment reliability. Conversely, those in lower credit bands are experiencing sharper declines in payment rates and borrowing more due to the pressures of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it awaits for inflation metrics to stabilize toward the central bank’s target of 2% before proceeding with anticipated rate cuts.
Despite preparations by banks for potential defaults later in the year, Mulberry emphasized that current default rates do not yet indicate a consumer crisis. He pointed to the difference in experiences between homeowners and renters during the pandemic.
“Although rates have increased significantly, homeowners locked in low fixed rates on their debts, so they aren’t feeling the financial strain as acutely,” Mulberry explained. “In contrast, renters missed that opportunity.”
With rents rising over 30% nationwide and grocery costs increasing by 25% from 2019 to 2023, renters are particularly feeling the financial pressure, as their rising expenses outpace wage growth.
So far, the earnings reports from the banks indicate stability in asset quality. Narron noted that robust revenues, profits, and solid net interest income reflect a resilient banking sector.
“There remains strength within the banking system, which is somewhat expected, but reassuringly, it indicates the financial structures in place are still robust,” Mulberry concluded. “However, we will be monitoring the situation closely, as prolonged high-interest rates could lead to greater stress in the system.”