As interest rates reach levels not seen in over twenty years and inflation continues to challenge consumers, major banks are bracing themselves for potential risks associated with their lending activities.
In the second quarter, major financial institutions including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside to address potential losses from credit risks, such as unpaid debts and troubled loans, particularly in commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit losses, while Bank of America set aside $1.5 billion. Citigroup’s credit loss allowance reached $21.8 billion at the end of the quarter, marking a significant increase from the previous quarter. Wells Fargo reported $1.24 billion in provisions.
These increased reserves indicate that banks are preparing for a more challenging financial environment, where both secured and unsecured loans pose heightened risks. Recent findings from the New York Federal Reserve revealed that total household debt in the U.S. has climbed to $17.7 trillion across consumer loans, student loans, and mortgages.
Additionally, the rise in credit card issuance and delinquency rates suggests that consumers are increasingly relying on credit as their savings from the pandemic era diminish. Credit card balances topped $1.02 trillion in the first quarter of this year, marking the second consecutive quarter of balances exceeding the trillion-dollar threshold, according to TransUnion. The situation in the CRE sector also remains precarious.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that consumers’ financial health has largely rested on pandemic-related stimulus measures.
Experts warn that any issues facing banks are likely to emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported by banks reflect their expectations for the future rather than the recent past.
In the short term, banks anticipate slowing economic growth, rising unemployment, and potential interest rate cuts later in the year. These factors may lead to increased delinquency and default rates.
Citi’s chief financial officer, Mark Mason, pointed out that warning signs are particularly evident among lower-income consumers, whose savings have diminished since the pandemic. He highlighted that while the overall U.S. consumer remains resilient, there are significant disparities in financial behavior across different income and credit score segments.
The Federal Reserve has maintained interest rates at a high of 5.25-5.5%, awaiting stabilization in inflation toward its 2% target before considering rate cuts.
Despite the banks’ preparations for an uptick in defaults, the current rate of defaults does not yet indicate a consumer crisis, Mulberry noted. He is particularly observing the divide between homeowners and renters. Homeowners, who secured low fixed rates during the pandemic, do not feel as much financial strain as renters who face rising housing costs.
Between 2019 and 2023, rents have surged over 30% nationwide, while grocery prices have increased 25%. Renters unable to capitalize on low rates are facing greater financial pressure.
The latest earnings reports revealed that asset quality remains stable, with strong revenues and profits indicating a resilient banking sector. Narron concludes that the banks are in a sound position, though ongoing high-interest rates could induce more stress over time.