As interest rates hit two-decade highs and inflation continues to challenge consumers, major banks are preparing for potential risks stemming from 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 are funds banks reserve to cover potential losses related to credit risks, which include bad debt and loans, such as commercial real estate.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance reached $21.8 billion at the end of the quarter, more than tripling its reserves from the prior quarter, and Wells Fargo posted provisions of $1.24 billion.
These increased reserves indicate that banks are bracing for a more challenging environment, where both secured and unsecured loans may result in greater losses. A recent analysis by the New York Federal Reserve revealed that Americans carry a combined debt of $17.7 trillion from various consumer loans, student loans, and mortgages.
The issuance of credit cards and rising delinquency rates are also concerning as many consumers exhaust their pandemic-era savings and increasingly depend on credit. According to TransUnion, credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances exceeded the trillion-dollar threshold. Meanwhile, commercial real estate remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked, “As we emerge from the COVID era, the banking sector and consumer health were largely buoyed by stimulus support.”
However, challenges for banks may arise in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that the provisions reported each quarter are not reflective of recent credit quality but rather predictions of future developments.
“We’ve shifted from a model where provisions increased after loan defaults to one where macroeconomic forecasts influence provisioning,” Narron explained.
Currently, banks anticipate slowing economic growth, rising unemployment rates, and potential interest rate cuts later this year, which may lead to more delinquencies and defaults by year-end.
Citi’s chief financial officer, Mark Mason, pointed out that these issues tend to affect lower-income consumers the hardest, who have seen their savings decline since the pandemic.
“While the overall U.S. consumer remains resilient, there’s a notable divergence in performance based on FICO scores and income levels,” Mason stated. He noted that only the top income quartile has saved more than they did before 2019, with clients in the highest FICO brackets driving spending growth and maintaining solid payment rates. Conversely, those in lower FICO brackets are experiencing sharper declines in payment rates and are borrowing more due to the impacts of high inflation and interest rates.
The Federal Reserve continues to maintain interest rates at a 23-year high of between 5.25% and 5.5%, awaiting stabilization of inflation measures towards the central bank’s target of 2% before implementing anticipated rate cuts.
Despite banks preparing for an increase in defaults later this year, Mulberry indicated that current default rates do not signal an impending consumer crisis. He emphasized the distinction between homeowners and renters during the pandemic, noting that while interest rates have surged, homeowners secured low fixed rates and are less burdened by rising costs.
With national rent prices rising by over 30% and grocery bills increasing by 25% from 2019 to 2023, renters who did not benefit from low rates are feeling the financial strain more acutely.
Overall, the latest earnings reports indicate that “there was nothing new this quarter concerning asset quality,” according to Narron. Strong revenues, profits, and consistent net interest income suggest a robust banking sector.
Mulberry concluded, “There remains a degree of strength in the banking sector, which is a relief, affirming that the financial system’s structure is still sound. However, prolonged high interest rates will inevitably increase stress.”