As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for new challenges in their lending operations.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their reserves for credit losses compared to the previous quarter. These reserves are funds that banks set aside to cover potential future losses from credit risks, which include delinquent or bad debts and various types of loans, such as commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, marking a more than tripling of its reserves from the prior quarter. Wells Fargo reported provisions of $1.24 billion.
These increases suggest that banks are preparing for a riskier environment, anticipating that both secured and unsecured loans may lead to greater losses. An analysis by the New York Federal Reserve revealed that American households now owe a staggering $17.7 trillion in various forms of debt, including consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates have also begun to rise as individuals tap into their pandemic-era savings and increasingly rely on credit. In the first quarter, credit card balances surpassed $1.02 trillion, marking the second consecutive quarter in which total cardholder debts exceeded the trillion-dollar threshold. The commercial real estate market also continues to face uncertainty.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, emphasized that the banking sector is still in a transitional phase following the COVID-19 pandemic, noting the significant role of government stimulus in supporting consumers during this period.
However, challenges for banks are expected to emerge in the upcoming months. Mark Narron, a senior director with Fitch Ratings, stated that reserves set aside in any quarter do not necessarily indicate the current quality of credit but rather reflect banks’ expectations for future developments.
He noted a shift in how banks approach provisions, moving from a model driven by bad loans to one influenced by macroeconomic forecasts. Currently, banks are anticipating slower economic growth and an increase in unemployment, along with two potential interest rate cuts later this year, which could lead to higher rates of delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, pointed out that these warning signs predominantly affect lower-income consumers, whose savings have depleting since the pandemic began. He indicated that, while the overall U.S. consumer market appears resilient, there is notable disparity based on income levels.
Mason observed that only the wealthiest quartile of consumers have more savings now compared to early 2019. As a result, it is primarily customers with FICO scores above 740 who are driving spending growth and maintaining high repayment rates. Conversely, those with lower credit scores are experiencing rising borrowing and declining payment rates, feeling the acute effects of high inflation and interest rates.
The Federal Reserve continues to maintain interest rates at a 23-year high of 5.25-5.5% while awaiting inflation metrics to stabilize toward its 2% target before implementing anticipated rate cuts.
Despite the banks’ preparations for increased defaults later in the year, Mulberry notes that current default rates do not indicate a consumer crisis. He is particularly attentive to the differences between individuals who purchased homes during the pandemic and those who rented.
While interest rates have risen significantly, homeowners secured low fixed rates on their mortgages and are not yet experiencing financial strain. In contrast, renters face escalating costs, with rents rising by more than 30% nationally from 2019 to 2023 and grocery expenses increasing by 25% during the same time frame. These factors contribute to growing financial stress among renters who have not benefited from low rates.
Ultimately, the key takeaway from recent earnings reports is that there have been no alarming changes in asset quality. Strong revenues, profits, and resilient net interest income point to a still-healthy banking sector. Mulberry remarked that while the banking system remains fundamentally sound, prolonged high interest rates could introduce further strain in the future.