With interest rates at their highest levels in over twenty years and inflation continuing to pressure consumers, major banks are bracing 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 funds that financial institutions reserve to manage potential losses arising from credit risk, including bad debts and various lending activities, notably in commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, a significant increase from the previous period, and Wells Fargo reported provisions of $1.24 billion.
The increased reserves indicate that banks are preparing for a challenging environment, where both secured and unsecured loans may lead to greater losses. According to a recent analysis by the New York Fed, American households collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card issuance is rising, contributing to increasing delinquency rates as individuals deplete their pandemic-era savings and turn more to credit. Total credit card balances reached $1.02 trillion in the first quarter of this year—marking the second consecutive quarter in which these balances surpassed the trillion-dollar threshold, according to TransUnion. Additionally, the commercial real estate sector remains vulnerable.
Brian Mulberry, a portfolio manager at Zacks Investment Management, indicated that the financial health of consumers is still impacted by the governmental stimulus provided during the pandemic.
Challenges for banks may lie ahead. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, noted that the provisions reported by banks do not fully represent credit quality over the recent quarter, but rather reflect expectations for future trends.
Narron mentioned that the banking sector is forecasting slower economic growth, higher unemployment, and potential interest rate cuts in September and December, which could lead to increased delinquencies and defaults as the year concludes.
Citi’s CFO Mark Mason observed that credit concerns are primarily manifesting among lower-income consumers, who have seen their savings decline since the pandemic began.
Mason 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 bands.” He highlighted that only the highest-income segment has managed to preserve savings relative to pre-pandemic levels, with higher FICO score consumers driving spending and maintaining solid payment rates. In contrast, lower FICO score customers are experiencing significant challenges, as high inflation and interest rates push them to borrow more.
The Federal Reserve has maintained interest rates at a 23-year high range of 5.25% to 5.5%, awaiting stabilization of inflation measures toward the central bank’s 2% target before implementing anticipated rate cuts.
Despite concerns over default rates in the latter half of the year, Mulberry believes that current default levels do not indicate an imminent consumer crisis. He is monitoring the distinction between homeowners and renters during the pandemic, as homeowners locked in low fixed-rate mortgages, thereby avoiding immediate financial strain.
In contrast, renters, particularly those who did not benefit from low rates, face heightened challenges as rental prices have surged over 30% nationwide from 2019 to 2023, coupled with a 25% increase in grocery costs.
Despite these pressures, the most recent earnings reports suggest that “there was nothing new this quarter in terms of asset quality,” according to Narron. The banking sector continues to demonstrate resilience with strong revenues, profits, and robust net interest income.
Mulberry concluded, “There’s some strength in the banking sector that is reassuring, reflecting that the structures of the financial system remain robust at this time. Nonetheless, we must remain vigilant; prolonged high interest rates could introduce additional stress.”