As interest rates reach their highest point in over 20 years and inflation continues to impact consumers, major banks are gearing up for increased risks associated with their lending practices.
In the second quarter of the year, 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 set aside by financial institutions to mitigate potential losses from credit risks, including overdue payments, bad debts, and various loans such as commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion to cover credit losses in the second quarter. Bank of America allocated $1.5 billion, while Citigroup reported a total of $21.8 billion in credit loss allowance at the end of the quarter, more than tripling its reserve from the prior quarter. Wells Fargo also raised its provisions to $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging environment, where risks associated with both secured and unsecured loans may lead to larger losses. A recent report from the New York Federal Reserve highlighted that American households owe a total of $17.7 trillion across consumer loans, student loans, and mortgages.
There has also been a rise in credit card issuance and delinquency rates as consumers deplete their savings accumulated during the pandemic and turn increasingly to credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances exceeded a trillion dollars, according to TransUnion. Additionally, the status of CRE loans remains uncertain.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the financial landscape is still recovering from the impacts of COVID-19 and the extensive stimulus measures provided during that time.
Looking ahead, challenges for banks may arise in the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, explained that the provisions set aside by banks reflect their expectations about future credit quality rather than past performance.
Currently, banks foresee a slowdown in economic growth, an increase in unemployment rates, and anticipate two interest rate cuts later this year, which could lead to more delinquencies and defaults as the year progresses.
Citi’s CFO Mark Mason highlighted that the warning signs seem particularly pronounced among lower-income consumers, who have seen their savings diminish since the pandemic. While the overall U.S. consumer remains resilient, there is a noticeable divide in behavior and financial stability across different income levels.
Mason noted that only the highest-income quartile has more savings compared to early 2019, and that consumers with credit scores above 740 are driving growth in spending and maintaining higher payment rates. Conversely, those with lower credit scores are experiencing a significant decline in payment rates and are borrowing more amid rising inflation and interest rates.
The Federal Reserve’s decision to maintain interest rates at a range of 5.25-5.5% reflects its monitoring of inflation trends, aiming to stabilize towards the target rate of 2% before considering the anticipated rate cuts.
Despite banks readying themselves for possible defaults later in the year, the current situation does not indicate an imminent consumer crisis, according to Mulberry. He noted the contrasting experiences of homeowners, who secured low fixed rates on their mortgages during the pandemic, and renters, who have faced sharp increases in rental costs without the same financial advantages.
Between 2019 and 2023, rents surged by over 30%, while grocery prices rose by 25%. Renters are feeling the pressure as their monthly expenses rise faster than wage growth.
Overall, the latest earnings reports from the banks suggest stability rather than any alarming trends in asset quality. Strong revenues and profits, along with healthy net interest income, point to a robust banking sector. Mulberry expressed relief that fundamental financial structures remain sound, but cautioned that prolonged high-interest rates could lead to increased stress in the future.