As interest rates remain at their highest levels in over twenty years and inflation continues to pressure 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 raised their provisions for credit losses compared to the previous quarter. These provisions represent funds that banks allocate to account for possible losses stemming from credit risks, including defaults on loans like commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses during the quarter; Bank of America allocated $1.5 billion; Citigroup’s loss allowance reached $21.8 billion by the end of the quarter, reflecting a more than threefold increase from the prior quarter; and Wells Fargo recorded provisions of $1.24 billion.
These reserve increases indicate that banks are preparing for a riskier financial environment, where both secured and unsecured loans may lead to greater losses. A recent report by the New York Federal Reserve revealed that the total household debt in the U.S. has soared to $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
Moreover, both credit card issuance and delinquency rates are rising as consumers deplete their pandemic-era savings and turn more frequently to credit. The total outstanding credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, pointed out that while the banking sector and consumer health are influenced by the stimulus measures implemented during the pandemic, challenges for banks are anticipated in the coming months.
“The provisions observed in any given quarter do not necessarily mirror the credit quality from the previous three months; instead, they reflect what banks anticipate for the future,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group. He noted a shift from a historical pattern—where increasing loan defaults prompted higher provisions—to a situation where macroeconomic forecasts guide provisioning decisions.
In the short term, banks are anticipating a slowdown in economic growth, a rise in unemployment rates, and two potential interest rate cuts later this year, which could lead to more delinquencies and defaults by year-end.
Citi CFO Mark Mason emphasized that concerning trends are particularly evident among lower-income consumers, whose savings have dwindled since the pandemic. He stated that while the overall U.S. consumer remains resilient, performance diverges significantly across different income levels and credit scores.
“When examining our consumer clients, only the highest income quartile possesses more savings than at the start of 2019. It is the customers with FICO scores above 740 who are contributing to spending growth and maintaining high payment rates,” Mason noted. “In contrast, lower FICO band consumers are experiencing significant declines in payment rates and are increasing their borrowing due to the strains of high inflation and interest rates.”
The Federal Reserve is maintaining interest rates at a 23-year high of 5.25-5.5%, seeking stabilization in inflation measures toward its 2% target before implementing anticipated rate cuts.
Despite banks’ preparations for a rise in defaults, current data does not indicate a looming consumer crisis, according to Mulberry. He is observing the disparity between homeowners and renters who experienced the pandemic.
“While interest rates have risen significantly, homeowners secured low fixed rates on their debts and are not feeling the impact as much,” Mulberry explained. “On the other hand, renters, who missed that opportunity, are facing rising rent costs.”
Rents have surged over 30% nationwide from 2019 to 2023, with grocery prices similarly increasing by 25%, exacerbating financial stress for renters whose budgets are outpacing wage growth.
For now, the latest earnings reports suggest that there are no new concerns regarding asset quality. Strong revenues, profits, and resilient net interest income indicate a banking sector that remains largely healthy. Mulberry remarked that there is strength in the banking industry, providing reassurance about the financial system’s stability as long as high-interest rates persist, though the situation warrants close monitoring.