As interest rates reach their highest levels in over 20 years and inflation continues to impact consumers, major banks are bracing for potential risks in their lending activities.
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 represent funds that banks set aside to cover possible losses from credit risks, including delinquent loans and commercial real estate (CRE) lending.
Specifically, JPMorgan increased its credit loss provisions by $3.05 billion; Bank of America set aside $1.5 billion; Citigroup raised its allowance for credit losses to $21.8 billion, which more than tripled its previous credit reserve; and Wells Fargo allocated $1.24 billion.
This buildup of reserves indicates that banks are preparing for a more challenging environment where both secured and unsecured loans could result in significant losses. A recent analysis by the New York Fed revealed that American household debt has surged to $17.7 trillion across consumer loans, student loans, and mortgages.
Moreover, credit card issuance and delinquency rates have been rising as consumers deplete their pandemic savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar mark, according to TransUnion. CRE lending remains particularly vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that we are still navigating the aftermath of the COVID-19 pandemic, with a significant impact stemming from government stimulus provided to consumers.
Looking ahead, any challenges facing banks are likely to emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported by banks reflect future expectations rather than recent credit quality.
Banks are anticipating slower economic growth, increased unemployment, and two interest rate cuts later this year, potentially leading to more delinquencies and defaults as the year concludes.
Citi’s chief financial officer Mark Mason highlighted that warning signs are particularly evident among lower-income consumers, who have seen their savings dwindle since the pandemic.
Mason stated that while the overall U.S. consumer remains resilient, there is a noticeable divergence based on income and credit scores. He indicated that only the top income quartile has more savings today than at the beginning of 2019, with higher credit score customers driving spending growth, while lower credit score customers are experiencing sharper declines in payment rates and are borrowing more, affected by high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it monitors inflation trends towards its 2% target before implementing anticipated rate cuts.
Despite banks preparing for increased defaults later this year, Mulberry noted that defaults are not yet rising to levels indicative of a consumer crisis. He highlighted the contrast between homeowners and renters during the pandemic, explaining that homeowners who secured low fixed-rate mortgages are largely insulated from the current economic pressures, while renters face much higher housing costs without the benefit of low locked-in rates.
Between 2019 and 2023, rents surged over 30% while grocery costs increased by 25%, putting additional strain on renters whose wages have not kept pace with rising rental prices.
Current earnings reports indicate that there has not been any significant change in asset quality this quarter. Strong revenues, profits, and resilient net interest income suggest that the banking sector remains fundamentally healthy.
Mulberry remarked that while there are positive indicators in the banking industry, the persistence of high interest rates will continue to exert pressure on the economy.