With interest rates at their highest levels in over two decades and inflation affecting consumers, leading banks are bracing for increased risks in their lending practices.
In the second quarter, major banks including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo elevated their provisions for credit losses from the previous quarter. These provisions are reserves that financial institutions allocate to offset potential losses from credit risks, such as delinquent debts and various forms of lending, including commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses; Bank of America earmarked $1.5 billion; Citigroup’s total allowance reached $21.8 billion, more than tripling its reserves from the previous quarter; and Wells Fargo put aside $1.24 billion.
The increase in reserves highlights the banks’ anticipation of a riskier lending environment, where both secured and unsecured loans could lead to significant losses. According to recent data from the New York Fed, American households collectively owe approximately $17.7 trillion in consumer loans, student debts, and mortgages.
Moreover, the issuance of credit cards and delinquency rates are rising as people deplete their pandemic-era savings, increasingly relying on credit. Credit card balances surpassed $1 trillion for the second consecutive quarter, as reported by TransUnion. The commercial real estate sector remains particularly vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented, “We’re still emerging from the COVID era, and the health of the consumer was largely supported by stimulus measures.”
Challenges for banks may surface in the coming months. Mark Narron, a senior director in Fitch Ratings, stated, “Current provisions do not necessarily reflect past credit quality but are based on banks’ expectations of future conditions.”
He noted that the economic forecasts suggest slowing growth, increased unemployment, and anticipated interest rate cuts in September and December, which could lead to more delinquencies by year-end.
Citi’s CFO Mark Mason highlighted that the issues appear more pronounced among lower-income consumers, who have seen their savings diminish since the pandemic. “While the overall U.S. consumer remains resilient, we observe a divergence in performance across different income levels,” he explained.
He noted that only the highest income quartile has greater savings compared to early 2019, with customers having a credit score above 740 driving spending growth and maintaining higher payment rates. Conversely, those in lower FICO bands are experiencing larger declines in payment rates and are borrowing more due to the effects of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year peak of 5.25-5.5%, waiting for inflation metrics to stabilize towards the central bank’s 2% target before considering rate cuts.
Although banks are preparing for a potential increase in defaults later this year, Mulberry indicated that defaults are not currently escalating to levels indicative of a consumer crisis. He is particularly observing the divide between pandemic homeowners and renters.
“Homeowners have locked in low fixed rates, so they aren’t feeling the financial pressure as much,” he noted, while renters face rising rents and grocery prices that have increased significantly since 2019, leading to more strain in their budgets.
Overall, analysts believe that recent earnings reveal no significant shifts in asset quality. With strong revenues, profits, and resilient net interest income, the banking sector remains fundamentally robust. Mulberry remarked, “There’s a strength in the banking sector that’s reassuring, but the prolonged high interest rates are a growing concern.”