As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks in their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all heightened their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks set aside to mitigate potential losses from credit risk, which could include defaults on loans, such as those in commercial real estate.
JPMorgan reported a provision for credit losses of $3.05 billion, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses climbed to $21.8 billion by the end of the quarter, more than tripling its earlier reserves. Wells Fargo’s provisions amounted to $1.24 billion.
These increases in reserves indicate that banks are preparing for a potentially riskier lending environment, where both secured and unsecured loans may lead to more significant losses. A recent study from the New York Fed revealed that Americans currently owe $17.7 trillion in various forms of household debt, including consumer loans, student loans, and mortgages.
The rise in credit card issuance, alongside increasing delinquency rates, reflects growing reliance on credit as many people’s savings from the pandemic begin to deplete. As of the first quarter this year, total credit card balances reached $1.02 trillion, marking the second consecutive quarter exceeding the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also remains vulnerable.
“Recovery from the COVID era is ongoing, and the consumer’s financial situation was heavily influenced by the stimulus provided,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, experts caution that banks may face challenges in the coming months. “The provisions recorded in any quarter don’t necessarily indicate the credit quality for that specific period; they reflect banks’ expectations for future conditions,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He further highlighted a shift from a historical approach where worsening loan quality prompted increased provisions to a system now influenced heavily by macroeconomic forecasts.
In the near future, banks are anticipating slowing economic growth, a higher unemployment rate, and potential interest rate cuts later this year, which could lead to increased delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, pointed out that the current signs of concern are particularly evident among lower-income consumers who have seen their savings diminish since the pandemic began. “While the overall U.S. consumer appears resilient, we are witnessing a variation in performance across different income brackets,” he noted.
He added, “Among our consumer clients, only the top income quartile has more savings than they did in early 2019, and those with strong credit scores are driving spending growth and maintaining high payment rates. However, customers in lower credit ranges are experiencing more significant declines in payment rates and are increasing their borrowing due to heightened inflation and interest rates.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, waiting for inflation measures to align with its 2% target before implementing expected rate cuts.
Despite preparations for an uptick in defaults in the latter part of the year, Mulberry notes that defaults have not yet surged to levels indicative of a consumer crisis. He suggests monitoring the difference between current homeowners and renters during this time. “Homeowners who secured low fixed rates on their mortgages are less impacted by interest rate hikes than renters who missed that opportunity,” Mulberry explained.
Rent prices have soared more than 30% nationally from 2019 to 2023, paired with a 25% increase in grocery costs, putting significant financial pressure on renters who have not benefited from low-rate mortgages.
Overall, the recent earnings reports suggest stability in asset quality, according to Narron. Strong revenues, profits, and solid net interest income indicate that the banking sector remains largely healthy. “There is some strength in the banking sector that may not have been fully anticipated, which is reassuring as the financial system maintains its robustness at this time,” Mulberry concluded. However, he warns that prolonged high-interest rates could lead to increased stress in the future.