With interest rates reaching their highest levels in over two decades and inflation continuing to burden consumers, major banks are preparing for increased risks associated with 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 represent the funds that banks allocate to potentially cover losses from credit risks, such as bad debt and 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 ended the quarter with a credit loss allowance of $21.8 billion, more than tripling its reserves from the previous quarter. Wells Fargo had provisions amounting to $1.24 billion.
The increase in provisions indicates that banks are bracing for a more challenging economic environment, where both secured and unsecured loans might lead to larger losses. According to a recent analysis by the New York Fed, Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are rising as individuals deplete their pandemic-era savings and increasingly rely on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold, as reported by TransUnion. Meanwhile, commercial real estate remains in a precarious situation.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, pointed out that the banking environment and consumer health have been heavily influenced by the stimulus measures deployed during the pandemic.
Challenges for banks are anticipated in the upcoming months. According to Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, the current provisions do not necessarily reflect recent credit quality but rather expectations for the future.
Currently, banks are forecasting a slowing economy, an increase in unemployment, and two interest rate cuts later this year during September and December. This may contribute to more delinquencies and defaults as the year progresses.
Citigroup CFO Mark Mason highlighted that the issues appear to be concentrated among lower-income consumers, who have seen their savings diminish since the pandemic. He noted that while the overall U.S. consumer remains resilient, the spending and payment behaviors vary greatly across different income levels and credit scores.
Only the highest income quartile has maintained higher savings since early 2019, with customers holding FICO scores above 740 driving spending growth and keeping up with payment rates. In contrast, those with lower FICO scores are experiencing significant drops in payment rates while borrowing more and facing the impacts of high inflation and interest rates.
The Federal Reserve currently maintains interest rates at a 23-year high of 5.25-5.5%. The central bank plans to hold off on rate cuts until inflation measures stabilize toward its 2% target.
Despite banks preparing for an increase in defaults later this year, Mulberry stated that defaults have not yet risen to a level indicating a consumer crisis. He is particularly observing the differences between homeowners and renters during this period.
Homeowners, who took advantage of low fixed interest rates, are not feeling the financial strain as severely as renters, who have faced significant rent increases—over 30% nationwide from 2019 to 2023—and rising grocery costs, meanwhile their wages have not kept pace.
For now, the most significant conclusion from the recent earnings reports is that asset quality remains stable. Positive indicators such as strong revenues, profits, and net interest income suggest a still-robust banking sector.
Mulberry commented on the strength of the banking sector, indicating that its foundations are sound, though he cautions that sustained high interest rates could lead to increased stress on consumers and the economy.