With interest rates reaching levels not seen in over two decades and inflation continuing to pressure 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 banks set aside to cover potential losses from credit risks, including delinquent loans and bad debt related to areas like commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citi’s allowance reached $21.8 billion, more than tripling its reserves from the prior quarter; and Wells Fargo’s provisions totaled $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans may lead to greater losses for some of the nation’s largest financial institutions. According to a recent analysis from the New York Fed, American households carry a collective debt of $17.7 trillion across various loans, including consumer and mortgage debts.
Additionally, the rate of credit card issuance is rising, alongside delinquency rates, as consumers deplete their pandemic savings and turn increasingly to credit for expenses. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total balances surpassed one trillion dollars, as reported by TransUnion. The situation in commercial real estate remains particularly concerning.
Experts note that the lingering effects of the COVID era, including extensive government stimulus, continue to impact consumer health. However, challenges for banks are anticipated in the forthcoming months.
“The provisions reported in any quarter typically do not reflect recent credit quality. Instead, they are based on what banks expect to occur in the future,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group. “Historically, provisions increased when loans started to perform poorly, but now macroeconomic forecasts predominantly drive these decisions.”
In the near future, banks expect a slowdown in economic growth, a rise in unemployment, and two interest rate cuts scheduled for September and December. These developments could lead to increased delinquencies and defaults as the year concludes.
Citi’s CFO Mark Mason emphasized that the concerns appear particularly pronounced among lower-income consumers, who have experienced significant declines in savings since the pandemic. “While the U.S. consumer remains generally resilient, there is a noticeable divergence in performance and behavior across different income and credit score levels,” he noted.
Currently, only the highest income quartile has more savings than they did at the start of 2019, and it is the higher credit score customers who are driving spending growth and maintaining payment levels. In contrast, those in lower credit bands are seeing a drop in payment rates as they are more severely affected by rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stable inflation measures to approach its 2% target before implementing anticipated rate cuts.
Despite banks bracing for more defaults later in the year, Mulberry noted that current default rates have not yet suggested a consumer crisis. “I’m paying attention to the distinction between homeowners and renters from the pandemic period,” he stated. Homeowners, who secured low fixed rates, are largely shielded from the current challenges, while renters face significant budget stress due to rising rents, which have increased over 30% nationally from 2019 to 2023, and grocery costs, which have surged by 25% in the same interval.
Overall, the latest earnings reports indicate that there haven’t been any alarming changes in asset quality. Strong revenues, healthy profits, and robust net interest income all point to a resilient banking sector. Mulberry concluded that while the financial system remains sound, ongoing high interest rates will continue to exert pressure.