As interest rates remain at their highest level in more than two decades 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 all increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside by financial institutions to cover potential losses from credit risk, which includes issues like delinquent loans and commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s credit loss allowance reached $21.8 billion by the end of the quarter, more than tripling its reserve from the prior quarter. Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging financial environment, where both secured and unsecured loans could lead to greater losses. Recent analysis by the New York Fed revealed that American households have accumulated a total of $17.7 trillion in consumer loans, student loans, and mortgages.
There is also a noticeable rise in credit card issuance and delinquency rates as consumers deplete their pandemic-era savings and increasingly rely on credit. Credit card balances surged to $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. Additionally, the commercial real estate sector remains in a precarious situation.
“We’re still emerging from the COVID-19 era,” commented Brian Mulberry, a client portfolio manager at Zacks Investment Management. “Much of the consumer financial health during this time can be attributed to the stimulus that was provided.”
Experts suggest that any potential issues for banks may arise in the coming months. “The provisions reported for any given quarter do not necessarily reflect the credit quality for the preceding three months but rather what banks anticipate for the future,” said Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
Narron noted a shift in the banking sector’s approach—moving from a system where provisions would rise with increasing loan defaults to one where macroeconomic forecasts largely drive provisioning decisions. Banks are currently forecasting slower economic growth, higher unemployment rates, and potential interest rate cuts in September and December, which could lead to increased delinquencies and defaults as the year comes to a close.
Citi’s chief financial officer Mark Mason remarked that the emerging red flags appear to be mainly affecting lower-income consumers, who have seen their savings dwindle since the pandemic. “While the overall U.S. consumer remains resilient, there is a noticeable divergence in performance based on FICO scores and income levels,” he stated.
Currently, only the highest-income quartile has more savings than they did in early 2019, with growth in spending driven primarily by customers with credit scores above 740. In contrast, individuals in lower FICO bands are experiencing declines in payment rates and increasing borrowing in response to high inflation and interest rates.
The Federal Reserve continues to maintain interest rates at a 23-year peak of 5.25-5.5%, waiting for inflation to stabilize toward its 2% target before considering anticipated rate cuts.
Despite banks’ preparations for a rise in defaults later this year, Mulberry suggests that defaults have not yet escalated to a level indicative of a consumer crisis. He notes the disparity between homeowners and renters during the pandemic, with homeowners benefiting from low fixed-rate mortgages, thus largely avoiding current financial strains. Meanwhile, renters face significant challenges due to rising rents, which have increased over 30% nationally from 2019 to 2023, alongside a 25% rise in grocery costs.
Overall, the latest earnings reports indicate that there are no significant changes in asset quality. Resilient revenues, profits, and net interest income suggest that the banking sector remains healthy. “There is some strength in the banking sector that offers a sense of relief, indicating that the structures of the financial system are still strong,” Mulberry concluded. However, he cautioned that prolonged high interest rates could increase stress on the system.