With interest rates at their highest levels in over 20 years and inflation continuing to impact 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 raised their provisions for credit losses, which are the funds that financial institutions set aside to cover potential losses from credit risks, including defaults and problematic loans such as those tied to commercial real estate.
JPMorgan set aside $3.05 billion for credit losses in the quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance reached $21.8 billion by the quarter’s end, marking a more than tripling of its credit reserve compared to the prior quarter, and Wells Fargo accounted for $1.24 billion in provisions.
These increased reserves indicate that banks are preparing for a more uncertain economic landscape, where both secured and unsecured loans may lead to greater losses for the nation’s largest banks. A recent New York Fed analysis highlighted that American households collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as individuals deplete their pandemic savings and increasingly rely on credit. The first quarter of this year saw credit card balances soar to $1.02 trillion, the second consecutive quarter surpassing the trillion-dollar threshold, according to TransUnion. The state of commercial real estate also remains precarious.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented, “We’re still emerging from the COVID era, especially concerning banking and consumer health, largely due to the stimulus provided during the pandemic.”
However, any significant challenges for banks are anticipated in the coming months.
Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained, “The provisions reported in any quarter reflect what banks expect will happen in the future, not necessarily the quality of credit over the last three months.”
He noted a shift in the banking system from reacting to bad loans to one where macroeconomic forecasts largely dictate provisioning. In the short term, banks anticipate slower economic growth, rising unemployment, and potential interest rate cuts later this year, which may lead to higher delinquency and default rates as the year concludes.
Citigroup’s CFO, Mark Mason, observed that concerns are primarily affecting lower-income consumers, who have experienced a significant depletion of savings since the pandemic. “While we see overall resilience in the U.S. consumer, we also notice divergence in financial performance and behavior across different income and credit score brackets,” he stated.
Mason further highlighted that only the highest income quartile holds more savings than before 2019, with affluent consumers driving spending growth and maintaining stable payment rates. In contrast, lower-income borrowers are facing greater payment rate declines and increased borrowing, heavily impacted by inflation and rising interest rates.
The Federal Reserve currently maintains interest rates at a 5.25-5.5% range, the highest in 23 years, awaiting stabilization in inflation to approach the central bank’s 2% target before implementing anticipated rate cuts.
Despite banks prepping for potential defaults later in the year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He pointed out that homeowners who secured low fixed-rate mortgages during the pandemic aren’t feeling the financial strain as intensely as renters, who have seen rents rise over 30% nationwide from 2019 to 2023 and grocery costs increase by 25% in the same timeframe.
Overall, Mulberry noted that the latest earnings report showed no significant new issues related to asset quality. Strong revenues, profits, and resilient net interest income are reassuring signs of a robust banking sector. “The financial system’s structure remains strong and sound, but we are closely monitoring the situation, as prolonged elevated interest rates can lead to increased stress,” Mulberry concluded.