As interest rates reach the highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for heightened risks related to their lending practices.
In the second quarter of the year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo have all increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks set aside to manage potential losses from credit-related challenges, including defaults on loans such as commercial real estate 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 prior quarter, and Wells Fargo accounted for $1.24 billion.
These increased reserves reflect the banks’ anticipation of a challenging lending environment, where both secured and unsecured loans may lead to more significant losses. Recent data from the New York Fed indicated that the total household debt in the U.S. has reached $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
Credit card issuance has also surged, contributing to a rise in delinquency rates as individuals exhaust their pandemic-era savings and increasingly rely on credit. According to TransUnion, credit card balances soared to $1.02 trillion in the first quarter, marking the second consecutive quarter in which balances exceeded the trillion-dollar threshold. The commercial real estate sector remains particularly vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the situation, emphasizing that the banking sector is still adjusting to the effects of the COVID-19 pandemic and the stimulus measures that supported consumers.
Experts indicate that any difficulties for banks are likely to manifest in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported by banks are more indicative of future expectations rather than reflecting past credit performance.
Currently, banks foresee slowing economic growth, increased unemployment, and potential interest rate cuts later this year, which may lead to higher rates of delinquency and defaults toward the year’s end.
Citigroup’s chief financial officer, Mark Mason, highlighted a concerning trend, noting that red flags are particularly evident among lower-income consumers who have depleted their savings since the pandemic began. He pointed out that only the wealthiest income quartile has managed to increase their savings since 2019.
Mason also observed that consumers with higher FICO scores are driving spending growth and maintaining strong payment rates, while those in lower FICO brackets are experiencing more significant declines in payment rates and are borrowing more due to the challenges posed by rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it seeks stabilization in inflation toward its 2% target before moving forward with anticipated rate cuts.
Despite preparations for a potential increase in defaults in the coming months, current data does not indicate a consumer crisis, according to Mulberry. He remarked on the differences between homeowners and renters during the pandemic, noting that homeowners secured low fixed rates on their debts while renters struggled with rising costs.
With rental prices increasing over 30% nationwide from 2019 to 2023 and grocery prices climbing 25%, renters are facing the most significant pressure on their budgets.
Overall, the latest earnings reports suggest that the banking sector remains in good shape, with strong revenues, profits, and stable net interest income. Mulberry expressed relief at the resilience of the financial system, although he cautioned that continued high interest rates will increase stress on consumers and banks alike.