Amidst interest rates reaching a twenty-year high and inflation pressures mounting on consumers, major banks are bracing for heightened risks associated with 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 that banks set aside to address potential losses arising from credit risks, such as bad debts and troubled loans, including those tied to commercial real estate.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s provision reached $21.8 billion, significantly surpassing its previous quarter’s figure; and Wells Fargo reported $1.24 billion in provisions.
This accumulated funding reflects banks’ caution in a challenging environment where both secured and unsecured loans might lead to increased losses for the country’s largest financial institutions. A recent report from the New York Fed indicated that American households are burdened with a collective $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, there is a rise in credit card issuance and delinquency rates as consumers deplete their pandemic-related savings and increasingly turn to credit. Credit card debt hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances exceeded one trillion dollars, as reported by TransUnion. The commercial real estate sector is also facing significant strain.
“We are emerging from the COVID era, and the banking sector, along with consumer health, has largely benefited from the stimulus measures that were introduced,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, challenges for banks may lie ahead.
“The provisions reported in any given quarter don’t necessarily align with actual credit quality from the previous three months; instead, they reflect the outlook banks have for the future,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
“It’s noteworthy that we’ve shifted from a historical model—where increasing bad loans triggered higher provisions—to a framework where macroeconomic forecasts heavily influence provisioning strategies,” he added.
In the short term, banks are anticipating a slowdown in economic growth, an uptick in unemployment rates, and possible interest rate cuts later this year in September and December. This environment could lead to an increase in delinquencies and defaults as the year progresses.
Citigroup’s chief financial officer, Mark Mason, highlighted that these warning signs appear to be more pronounced among lower-income consumers, who have seen their savings diminish since the pandemic.
“While we observe a resilient overall U.S. consumer, there remains a noticeable divergence in performance and behavior across different income levels and credit scores,” Mason mentioned during a recent analyst call.
“Examining our consumer clients, only those in the highest income quartile have managed to maintain more savings than they had at the beginning of 2019, with high FICO score customers contributing to spending growth and sustaining high payment rates,” he indicated. “In contrast, those with lower FICO scores are experiencing declining payment rates and increasing borrowing 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% while awaiting stabilization in inflation rates towards its target of 2% before proceeding with anticipated rate cuts.
Despite banks bracing for higher defaults in the latter part of the year, current default rates do not suggest an impending consumer crisis, according to Mulberry. He is particularly observing the distinction between homeowners and renters from the pandemic phase.
“While rates have significantly increased, homeowners have largely locked in low fixed rates on their debts and are not feeling as much of the financial strain,” Mulberry noted. “Renters, on the other hand, missed out on this opportunity.”
With rents soaring over 30% nationwide from 2019 to 2023 and grocery prices increasing by 25% during the same timeframe, renters without fixed low rates are experiencing notable financial strain, as stated by Mulberry.
Currently, the overarching insight from the recent earnings reports indicates that “there was nothing unexpected this quarter regarding asset quality,” according to Narron. Positive metrics such as strong revenues, profits, and resilient net interest income signal a healthy banking sector.
“There remains considerable strength within the banking sector, which is reassuring given the current circumstances. However, we must be vigilant, as prolonged high interest rates can augment stress within the system,” Mulberry concluded.