As interest rates reach levels not seen in over two decades and inflation continues to impact consumers, major banks are bracing for increased risks related to their lending practices.
In the second quarter, top financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their reserves for credit losses compared to the previous quarter. These reserves represent funds set aside to cover potential losses from credit risks, including delinquencies and bad debts, particularly concerning commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses during the second quarter; Bank of America added $1.5 billion to their reserves; Citigroup’s allowance for credit losses rose to $21.8 billion by the end of the quarter, more than tripling its reserves from the previous period; and Wells Fargo set aside $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans may lead to greater losses for some of the country’s largest banking institutions. A recent analysis by the New York Federal Reserve found that Americans now carry a collective debt of $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card use is also on the rise, with increasing delinquency rates as consumers deplete their pandemic-era savings and rely more heavily on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector remains particularly vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector is still adjusting from the COVID era, driven largely by consumer stimulus measures. However, challenges for banks may manifest in the coming months.
Mark Narron, a senior director at Fitch Ratings, explained that current provisions for credit losses do not necessarily reflect past credit quality but are based on future expectations. He emphasized the shift in how banks are viewing provisioning, moving from a response-driven system to one now influenced heavily by macroeconomic forecasts.
In the near future, banks anticipate slower economic growth, a rising unemployment rate, and potential interest rate cuts in September and December, which could lead to more delinquencies and defaults as the year progresses.
Citigroup’s CFO Mark Mason highlighted a troubling trend among lower-income consumers, who have seen their financial reserves diminished since the pandemic. He reported that while the overall U.S. consumer appears resilient, there is a disparity in performance across income levels and credit scores.
According to Mason, only the highest income quartile has maintained more savings than they had at the start of 2019, and the growth in spending is largely driven by customers with credit scores over 740. In contrast, lower credit score customers are facing significant payment rate declines and are increasing their borrowing, heavily impacted by high inflation and interest rates.
The Federal Reserve has kept interest rates at a 23-year peak of 5.25-5.5%, awaiting signs of stabilization in inflation toward its 2% target before proceeding with anticipated rate cuts.
Despite banks readying themselves for potential increases in defaults later this year, current delinquency rates do not indicate a consumer crisis, according to Mulberry. He is particularly interested in the difference between homeowners during the pandemic and those who rent, noting that while interest rates have risen substantially, homeowners secured low fixed rates and have largely avoided significant financial pain.
In contrast, renters have been affected by rising housing costs, which have surged more than 30% from 2019 to 2023, coupled with a 25% increase in grocery expenses during the same period. Those who did not lock in lower rates are experiencing the most financial strain in their budgets.
Overall, the latest earnings reports suggest stability in the banking sector, with healthy revenues, profits, and net interest income. Narron remarked that there were no major new issues regarding asset quality this quarter. Mulberry also expressed relief that the financial system remains strong but cautioned that prolonged high interest rates could lead to increased stress in the future.