As interest rates remain at their highest levels in over 20 years and inflation continues to impact 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 raised their provisions for credit losses compared to the previous quarter. These provisions represent the funds that financial institutions set aside to cover potential losses related to credit risks, including bad debts and delinquent loans, particularly in commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, 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 reserves from the previous quarter. Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves indicate that banks are bracing for a more challenging lending environment, as both secured and unsecured loans may lead to greater losses. A recent analysis by the New York Fed revealed that American households collectively owe $17.7 trillion in consumer and student loans, as well as mortgages.
Additionally, credit card issuance and delinquency rates are climbing as people deplete their pandemic-era savings and increasingly rely on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter that total balances exceeded the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also faces significant challenges.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking industry is still recovering from the impacts of the COVID-19 pandemic, particularly in terms of consumer health, which was heavily supported by government stimulus.
However, banks are anticipating challenges in the months to come. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that the provisions made in any given quarter do not solely reflect recent credit quality but are influenced by future expectations.
As for the economic outlook, banks are forecasting slower growth, a higher unemployment rate, and potential interest rate cuts later this year. This could lead to an increase in delinquencies and defaults by year-end.
Citi’s chief financial officer, Mark Mason, highlighted concerns that the financial strain tends to affect lower-income consumers more significantly, as many have seen their savings dwindle since the pandemic.
Mason noted that while the U.S. consumer appears resilient overall, there exists a divergence in performance based on income levels and credit scores. Only the top income quartile has retained more savings than they had in early 2019. High-FICO score customers are showing growth in spending and maintaining payment rates, while those with lower scores are experiencing declines in payment rates and are increasingly relying on borrowing, feeling the impact of inflation and rising interest rates more acutely.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation toward its 2% target before implementing anticipated rate cuts.
Despite banks gearing up for more defaults in the second half of the year, Mulberry pointed out that the current default rates do not indicate a consumer crisis. He emphasized the distinction between homeowners who locked in low fixed rates during the pandemic and those renting, who have faced significantly higher costs.
With rents rising over 30% nationwide from 2019 to 2023 and grocery prices increasing by 25%, renters—especially those unable to secure low rates—are feeling more financial pressure.
Overall, the latest earnings reports suggest that there have been no significant changes in asset quality during this quarter. Strong revenues, profits, and solid net interest income reflect a still healthy banking sector.
Mulberry expressed relief that the banking system remains robust, although he cautioned that sustained high interest rates could lead to increased stress for consumers and financial institutions alike.