As interest rates reach their highest levels in over 20 years and inflation continues to challenge 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 funds that financial institutions set aside to cover potential losses from credit risks, including delinquent debts and various lending activities such as commercial real estate loans.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter, while Bank of America designated $1.5 billion. Citigroup reported an allowance for credit losses of $21.8 billion, which more than tripled its reserve from the prior quarter, and Wells Fargo set aside $1.24 billion.
These increased reserves signal that banks are preparing for a more challenging environment, where both secured and unsecured loans could lead to greater losses. A recent study by the New York Fed indicated that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards and the subsequent rise in delinquency rates are also significant, as many consumers deplete their pandemic-era savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where the total exceeded one trillion dollars, according to TransUnion. Additionally, commercial real estate remains in a vulnerable state.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted that the banking landscape and consumer health are still recovering from the effects of COVID, largely due to the stimulus measures implemented to support consumers.
Experts caution that any banking issues may emerge in the future. Mark Narron, a senior director at Fitch Ratings, explained that current provisions do not solely reflect credit quality from the past few months; rather, they are based on the banks’ expectations for future developments.
The banks project a slowdown in economic growth, a rise in unemployment, and potential interest rate cuts in September and December, which could lead to an increase in delinquencies and defaults by year-end.
Citi’s chief financial officer, Mark Mason, highlighted that concerning trends seem to be more pronounced among lower-income consumers, who have experienced a decline in savings since the pandemic.
“While we see resilience in the overall U.S. consumer, there is a notable divergence in performance across different income levels,” Mason stated. He noted that only the highest income quartile has more savings now than at the beginning of 2019, and that consumers with higher credit scores are driving spending growth and maintaining good payment rates. In contrast, those with lower credit scores face increased borrowing and declining payment rates, impacted by high inflation and interest rates.
The Federal Reserve has maintained interest rates between 5.25% and 5.5%, the highest in 23 years, as it awaits stabilization of inflation measures toward its target of 2% before implementing anticipated rate cuts.
Although banks are preparing for potential defaults later this year, Mulberry believes defaults are not yet rising sharply enough to indicate a consumer crisis. He is particularly focused on the contrast between homeowners and renters during the pandemic. Homeowners locked in low fixed mortgage rates, mitigating their financial stress, while renters face rising rents and escalating living costs without similar financial protections.
From 2019 to 2023, rents increased by over 30%, while grocery prices rose by 25%. Those who could not secure low rates during the pandemic are now experiencing the greatest strain on their finances.
For the moment, the recent earnings reports indicate that there are no significant new concerns regarding asset quality. Strong revenues, profits, and robust net interest income signal that the banking sector remains in good health.
“There is strength in the banking sector that might not have been entirely predicted, but it’s reassuring to see that the financial system remains solid,” Mulberry said. “However, we are closely monitoring the situation, as prolonged high interest rates could lead to increased stress.”