As interest rates remain at their highest levels in over two decades and inflation continues to exert pressure on consumers, major banks are preparing for potential risks associated with their lending practices.
During 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 serve as reserves set aside by financial institutions to cover potential losses from credit risks such as defaults and delinquent loans, particularly in commercial real estate (CRE).
JPMorgan allocated $3.05 billion in provisions for credit losses during the second quarter; Bank of America set aside $1.5 billion; Citigroup’s credit loss allowance reached $21.8 billion, more than triple its previous quarter’s reserve; and Wells Fargo established provisions of $1.24 billion.
These increased reserves highlight the banks’ anticipation of a more challenging lending environment, where both secured and unsecured loans could lead to greater losses. An analysis by the New York Fed revealed that American households hold a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance is also on the rise, with delinquency rates climbing as consumers begin to deplete their pandemic-era savings and increasingly turn to credit. In the first quarter, credit card balances hit $1.02 trillion, marking the second consecutive quarter where total cardholder balances exceeded one trillion dollars, according to TransUnion. Meanwhile, the CRE sector remains uncertain.
“We’re still emerging from the COVID era, and the health of the consumer within banking is significantly influenced by the stimulus provided to them,” commented Brian Mulberry of Zacks Investment Management.
Challenges for banks are expected to emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, pointed out that the provisions reported in any quarter do not necessarily indicate credit quality over the preceding three months; rather, they reflect banks’ future expectations.
“It’s interesting to note the shift from a system where provisions would rise alongside deteriorating loans to one where macroeconomic forecasts drive provisioning decisions,” he added.
In the short term, banks are predicting slower economic growth, higher unemployment rates, and possible interest rate cuts later this year. This could lead to an increase in delinquencies and defaults as the year comes to a close.
Citi’s CFO, Mark Mason, highlighted that concerns are primarily affecting lower-income consumers, who have seen their savings diminish since the pandemic.
“While we see resilience in the overall U.S. consumer, there is a noticeable divergence in performance based on income and credit scores,” Mason explained. He noted that only the highest income group has maintained more savings than they had at the start of 2019, and it is those with credit scores above 740 who are contributing to spending growth and consistently making payments. In contrast, those with lower credit scores are experiencing significant declines in payment rates and are accumulating more debt, largely due to the impacts of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25% to 5.5% as it awaits stabilization in inflation metrics toward its 2% target before considering anticipated rate cuts.
Despite banks preparing for a potential increase in defaults later this year, current trends do not indicate an imminent consumer crisis, according to Mulberry. He is particularly observing the differences between homeowners and renters since the pandemic.
“While rates have risen sharply, homeowners benefited from low fixed rates, which means they aren’t feeling the financial strain as acutely as renters, who haven’t had the same opportunity,” Mulberry said. “Rent costs have risen over 30% nationwide since 2019, and grocery prices have surged 25%, pushing renters into tighter budgets.”
However, the recent earnings reports indicate that there are no alarming changes in asset quality, according to Narron. Strong revenues, profits, and resilient net interest income signal a robust banking sector.
“There is a solidity in the banking sector that, while it may not have been unexpected, is nevertheless reassuring,” Mulberry noted. “Yet, we are monitoring the situation closely, as prolonged high interest rates may lead to increased stress.”