With interest rates reaching levels not seen in over 20 years and inflation continuing to pressure consumers, major banks are preparing for increased risks associated with their lending practices.
During 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 that financial institutions allocate to cover potential losses from credit risks, such as delinquent loans and bad debt, including commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, Bank of America allocated $1.5 billion, Citigroup’s allowance reached $21.8 billion—more than tripling its reserves from the prior quarter—and Wells Fargo had provisions amounting to $1.24 billion.
The increased reserves reflect the banks’ anticipation of a riskier lending environment, where both secured and unsecured loans might lead to more substantial losses. An analysis by the New York Fed indicated that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Rising credit card issuance and delinquency rates are linked to consumers depleting their pandemic-era savings and increasingly relying on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total balances exceeded the trillion-dollar threshold, according to TransUnion. Concurrently, commercial real estate continues to face challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the ongoing recovery from the COVID-19 pandemic and noted the role of government stimulus in maintaining consumer banking health.
However, the real challenges for banks may surface in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that current provisions do not directly reflect the credit quality of loans made in the last three months, as they are influenced by banks’ expectations of future conditions.
Banks are predicting slower economic growth, higher unemployment rates, and potential interest rate cuts later this year. These factors could lead to more delinquencies and defaults as the year progresses.
Citi’s chief financial officer, Mark Mason, highlighted concerns primarily among lower-income consumers, who have seen their savings decline since the pandemic. He noted that while the overall U.S. consumer is still resilient, there is a widening gap in performance and behavior across different income and credit score segments. Only the highest income quartile has retained more savings than in early 2019, while those with lower credit scores are experiencing increased borrowing and drops in payment rates due to economic pressures.
The Federal Reserve has maintained interest rates between 5.25% and 5.5%, remaining cautious until inflation stabilizes towards its target of 2% before implementing anticipated rate cuts.
Despite banks bracing for potential defaults in the latter half of the year, current default rates do not signal a consumer crisis, according to Mulberry. He noted that homeowners, who locked in low fixed rates during the pandemic, are less affected by rising rates compared to renters facing higher costs.
With rents increasing over 30% nationwide and grocery prices rising by 25% between 2019 and 2023, renters who have not benefited from low fixed rates are facing significant financial pressure, according to Mulberry.
Overall, recent earnings reports suggest stability within the banking sector, with no alarming changes in asset quality. Positive revenue, profit, and net interest income metrics indicate that the financial system remains robust. Mulberry expressed cautious optimism about the strength of the banking sector but acknowledged that sustained high-interest rates could lead to increased stress in the future.