As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for potential risks in their lending operations.
In the second quarter, four of the largest banks in the U.S.—JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo—have increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside by financial institutions to cover possible losses from credit risks, including overdue debts and loans that could default, particularly in sectors like commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup reported a staggering $21.8 billion in provisions by the end of the quarter, marking a more than threefold increase from the previous quarter. Wells Fargo recorded provisions totaling $1.24 billion.
These increased reserves reflect banks’ readiness for a riskier lending landscape, where the likelihood of larger losses on both secured and unsecured loans is heightened. According to a recent report by the New York Fed, total household debt in the U.S. has climbed to $17.7 trillion, encompassing consumer loans, student debt, and mortgages.
The trend of rising credit card issuance and delinquency rates is also concerning as individuals draw down savings accumulated during the pandemic and increasingly rely on credit. Outstanding credit card balances reached $1.02 trillion in the first quarter, representing the second consecutive quarter that this total surpassed a trillion dollars, as reported by TransUnion. The commercial real estate sector continues to face challenges.
Experts indicate that while the financial health of consumers seemed bolstered by government stimulus during the pandemic, the situation is shifting. Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted, “We’re still coming out of this COVID era,” emphasizing the role of stimulus in consumer spending.
Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported by banks do not solely reflect recent credit quality; instead, they reflect banks’ expectations regarding future economic conditions. He highlighted a shift from an historical model where provisions increased in response to loan defaults, to one where macroeconomic forecasts dictate lending reserves.
Looking ahead, banks anticipate slower economic growth, a rising unemployment rate, and potential interest rate cuts in September and December. This environment could lead to higher delinquencies and defaults as the year concludes.
Citigroup’s CFO, Mark Mason, pointed out that red flags are particularly pronounced among lower-income consumers, who have experienced depletion of their savings since the pandemic’s onset. He stated, “While we continue to see an overall resilient U.S. consumer, we also continue to see a divergence in performance and behavior across FICO and income band.”
Only the highest income quartile has seen an increase in savings since early 2019. Higher FICO score customers are contributing to spending growth and maintaining good payment rates, while those within lower FICO bands are facing increased difficulties, with rising borrowing and declining payment rates impacted by elevated inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high, between 5.25% and 5.5%, as it seeks to stabilize inflation towards its 2% target before implementing any anticipated rate cuts.
Despite preparations for a rise in defaults in the latter half of the year, Mulberry observed that defaults are not currently escalating to levels indicative of a consumer crisis. He is particularly focused on the distinction between homeowners and renters during this period of rising rates.
Mulberry explained that although interest rates have surged, homeowners locked in low fixed rates and are therefore not experiencing significant financial distress. In contrast, renters, who have faced escalating rents—up over 30% from 2019 to 2023—are likely to feel the effects of wage growth not keeping pace with rising costs in their monthly budgets.
Overall, the latest earnings reports noted that there were no significant changes in asset quality. Strong revenues, profits, and consistent net interest income suggest that the banking sector remains robust. Mulberry remarked, “The structures of the financial system are still very strong and sound at this point in time,” although he cautioned that prolonged high interest rates could introduce further challenges.