As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks tied to their lending practices.
In the second quarter of this year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions serve as financial cushions that banks set aside to cover potential losses from credit risks, such as delinquent debts and trouble with loans, particularly in the commercial real estate sector.
JPMorgan allocated $3.05 billion for credit loss provisions, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, more than tripling its reserve from the previous period, and Wells Fargo recorded provisions of $1.24 billion.
These additional reserves indicate that banks anticipate a riskier lending environment, where both secured and unsecured loans could lead to increased losses. A recent evaluation of household debt by the New York Fed revealed that Americans owe a total of $17.7 trillion across various loans, including consumer and student loans as well as mortgages.
Furthermore, an increase in credit card issuance has been accompanied by rising delinquency rates, as individuals exhaust their pandemic-era savings and increasingly rely on credit. In the first quarter of the year, credit card balances soared to $1.02 trillion, marking the second consecutive quarter where cardholder balances surpassed the trillion-dollar threshold, according to data from TransUnion. The commercial real estate market remains in a vulnerable position.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted, “We’re still coming out of this COVID era,” emphasizing that the health of consumers and banks was largely influenced by government stimulus provided during the pandemic.
Experts warn that any financial difficulties for banks are likely to manifest in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained, “The provisions seen in any given quarter don’t necessarily reflect the credit quality of the last three months, but rather what banks anticipate for the future.”
Currently, banks are forecasting slowing economic growth, an increase in the unemployment rate, and two anticipated interest rate cuts later this year in September and December. This outlook could lead to a rise in delinquencies and defaults as the year concludes.
Citigroup’s Chief Financial Officer, Mark Mason, highlighted that emerging issues are predominantly affecting lower-income consumers, who have experienced a decline in their savings since the pandemic began. “While we continue to see an overall resilient U.S. consumer, there is a divergence in performance based on income and credit ratings,” Mason reported.
He noted that, among their consumer clients, only those in the highest income bracket have more savings now than in early 2019. Customers with FICO scores above 740 are driving spending growth and maintaining high payment rates, while those in lower credit brackets are facing declining payment rates and increased borrowing due to the effects of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a high range of 5.25-5.5%, waiting for inflation measures to stabilize around its 2% target before implementing the expected rate cuts.
Despite banks preparing for a potential increase in defaults later this year, the current default rates do not suggest an immediate consumer crisis, according to Mulberry. He is monitoring the divide between homeowners who benefitted from low fixed rates during the pandemic and renters who did not have the same opportunity.
“While rates have significantly increased, homeowners are still largely insulated from pain as they locked in favorable rates. Renters, on the other hand, are facing challenges due to soaring rents and rising grocery costs, which have outpaced wage growth,” Mulberry explained.
Overall, the latest round of earnings reports indicates that there were no significant new developments regarding asset quality. Strong revenues, profits, and healthy net interest income are positive signs for the banking sector.
“There remains strength in the banking system that may have been underestimated,” said Mulberry. “However, consistent high interest rates will continue to create pressure.”