With interest rates at their highest level in over two decades and inflation continuing to pressure consumers, major banks are bracing for increased risks related to their lending practices.
In response to these challenges, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses during the second quarter. These provisions are essentially reserves set aside to cover potential losses from credit risks, which include delinquent debt and commercial real estate (CRE) loans.
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 by the end of the quarter, more than tripling its reserves from the previous quarter. Wells Fargo added $1.24 billion to its provisions.
These provisions indicate that banks are preparing for a more difficult financial environment, where both secured and unsecured loans could lead to greater losses. According to the New York Federal Reserve, American households currently owe a collective $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance is on the rise, with delinquency rates also increasing as consumers deplete their pandemic-era savings and rely more on credit. Total credit card balances hit $1.02 trillion in the first quarter, marking the second consecutive quarter that balances exceeded the trillion-dollar threshold, as reported by TransUnion. Furthermore, the commercial real estate sector remains uncertain.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, emphasized that the financial situation is evolving as the economy emerges from the COVID-era stimulus effects on consumer banking health.
However, any substantial issues for banks are likely to emerge in the coming months. Mark Narron from Fitch Ratings highlighted that current provisions do not necessarily reflect past credit quality but rather banks’ anticipations for the future.
He noted that the banking sector has shifted from a model where increasing loan delinquencies drive an increase in provisions to one where macroeconomic forecasts dictate provisioning strategies.
Banks are currently expecting slowing economic growth, rising unemployment, and potential interest rate cuts in September and December, which could lead to more delinquencies and defaults by year-end.
Citi’s chief financial officer, Mark Mason, pointed out that economic challenges appear more severe for lower-income consumers, who have seen their savings diminish over the pandemic years. He noted a stark contrast in financial behavior between higher-income and lower-income consumers.
While the overall U.S. consumer remains resilient, wealthier households generally have maintained or increased their savings since 2019, whereas lower-income consumers are facing difficulties due to high inflation and interest rates, resulting in increased borrowing and decreasing payment rates.
The Federal Reserve is holding interest rates at a 23-year high of 5.25-5.5% as it assesses inflation trends, awaiting stabilization toward its 2% target before considering rate cuts.
Despite the preparation for potential future defaults, Mulberry stated that current default rates do not indicate a widespread consumer crisis. He is particularly monitoring the differences between homeowners and renters during this economic period.
Homeowners, who benefitted from low fixed mortgage rates, are generally not feeling the financial strain. In contrast, renters face significant stress, experiencing a more than 30% increase in rents from 2019 to 2023, with grocery costs rising by 25%, which has outpaced wage growth.
Nonetheless, recent earnings reports indicate stability in the banking sector, with no significant changes in asset quality. Strong revenues and profits reflect a generally healthy financial environment, although industry experts remain cautious as long as high-interest rates persist.