As interest rates remain at their highest in over 20 years and inflation continues to impact consumers, major banks are bracing for potential risks associated with their lending practices.
In the second quarter, leading financial institutions like JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions serve as a financial buffer against potential losses from credit risks, including overdue payments and bad debts, especially in commercial real estate lending.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America prepared $1.5 billion. Citigroup’s total allowance for credit losses reached $21.8 billion at the quarter’s end, significantly higher than the previous quarter, and Wells Fargo recorded $1.24 billion in provisions.
This buildup indicates that banks are anticipating a more challenging environment ahead, where loans—both secured and unsecured—could lead to greater losses. According to a recent analysis by the New York Federal Reserve, total household debt in the U.S. has surged to $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as people deplete their pandemic savings and increasingly rely on credit. In the first quarter, credit card balances hit $1.02 trillion, marking the second consecutive quarter the total has exceeded this threshold, as reported by TransUnion. The commercial real estate sector remains particularly vulnerable during this period.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, highlighted that the ongoing recovery from the COVID-19 pandemic has been significantly influenced by stimulus efforts directed at consumers.
Looking forward, banks are preparing for upcoming challenges. Mark Narron, a senior director at Fitch Ratings, pointed out that the provisions observed each quarter reflect the banks’ expectations of future credit quality rather than past performance.
In the near future, banks are forecasting a slowdown in economic growth, rising unemployment rates, and potential interest rate cuts in September and December. These factors may lead to increased delinquencies and defaults by the year’s end.
Citigroup’s chief financial officer, Mark Mason, noted that financial distress is more pronounced among lower-income consumers, whose savings have diminished in the post-pandemic era.
Despite an overall resilient U.S. consumer landscape, Mason indicated a clear divide in financial stability across different income and credit score levels. Higher-income consumers, particularly those with credit scores above 740, have maintained their savings and spending. In contrast, lower-income consumers are experiencing declines in payment rates and are increasingly relying on credit as they grapple with high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation metrics to initiate anticipated rate cuts.
While banks are preparing for potential defaults later this year, current data does not suggest an impending consumer crisis, according to Mulberry. He pointed out the differing experiences of homeowners and renters during the pandemic. Homeowners, having locked in low fixed-rate mortgages, are not feeling as much financial strain as renters, whose costs have risen sharply.
From 2019 to 2023, rent prices have increased by more than 30%, while grocery expenses have surged by 25%, leaving renters with tighter budgets compared to homeowners, who benefited from lower interest rates.
Overall, the recent earnings reports do not indicate significant issues regarding asset quality, with strong revenues and profits reflecting a robust banking sector. Mulberry noted that while there is resilience within the financial system, prolonged high interest rates could introduce additional stress in the future.