As interest rates reach their highest level in over two decades and inflation continues to impact consumers, major banks are bracing for potential risks related to 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 consist of funds that financial institutions set aside to mitigate potential losses from credit risk, including defaults on loans and overdue debts.
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 by the end of the quarter, more than tripling its reserve from the previous quarter. Wells Fargo reported provisions of $1.24 billion.
This increase in reserves suggests that banks are preparing for a more challenging economic climate, where both secured and unsecured loans may lead to greater losses. A recent report by the New York Federal Reserve indicated that total household debt in the U.S. stands at $17.7 trillion, which includes consumer loans, student loans, and mortgages.
Furthermore, credit card issuance is on the rise, and delinquency rates are increasing as consumers exhaust their pandemic-era savings. 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 mark, according to TransUnion. Additionally, the commercial real estate sector remains under significant stress.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the impacts of COVID-19, particularly the distribution of stimulus funds, continue to influence the banking sector and consumer health.
Looking ahead, any challenges facing banks are anticipated to manifest in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that current provisions may not accurately reflect recent credit quality but rather represent banks’ expectations for future performance.
Banks are currently anticipating slower economic growth, a rise in unemployment, and possible interest rate cuts later this year, which could lead to increased delinquency and defaults as the year progresses.
Mark Mason, Citi’s chief financial officer, highlighted that warning signs of distress seem particularly pronounced among lower-income consumers, who have seen their savings diminish since the pandemic began. He noted that while the overall U.S. consumer remains resilient, there are notable disparities in spending and payment behaviors based on income levels and credit scores.
“The highest income quartile holds more savings than they did at the start of 2019,” Mason stated, adding that consumers with FICO scores over 740 are driving spending growth and maintaining high payment rates. In contrast, lower FICO customers are experiencing declines in payment rates and increasing debt burdens due to pressures from high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, waiting for indicators of inflation to align with its 2% target before making anticipated cuts.
Despite banks preparing for a potential rise in defaults later this year, Mulberry noted that current default rates do not point to a consumer crisis. He emphasized the distinction between existing homeowners and renters, stating that homeowners, who secured low fixed rates, are not feeling the impact of rising rates as acutely as renters.
With rents surging more than 30% nationwide from 2019 to 2023 and grocery prices increasing by 25%, renters who were unable to lock in low rates are under more financial strain compared to their homeowner counterparts.
Overall, Narron remarked that earnings reports indicated no new concerns regarding asset quality this quarter. Strong revenues and net interest income suggest that the banking sector remains in a robust state.
Mulberry affirmed a sense of relief regarding the structural soundness of the financial system despite the challenges posed by continued high interest rates, revealing an ongoing need for vigilance as the situation develops.