As interest rates reach their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their credit loss provisions compared to the previous quarter. These provisions represent the funds that banks allocate to cover anticipated losses from credit risks, which include delinquent loans and commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses rose to $21.8 billion, more than tripling its reserves from the prior quarter. Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves signal that banks are preparing for a more challenging financial environment, where both secured and unsecured loans could result in greater losses. According to a recent New York Fed analysis, American households now owe a total of $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise, as many consumers are depleting their pandemic-era savings and turning to credit. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where the total surpassed a trillion dollars, as reported by TransUnion. Additionally, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked on the lingering effects of the COVID-19 pandemic on banking and consumer health, attributing some stability to the stimulus measures implemented during that time.
However, potential challenges for banks may become more apparent in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions banks report are often a reflection of their future expectations rather than past credit quality.
Currently, banks anticipate slowing economic growth, an uptick in unemployment, and potential interest rate cuts in September and December, which could lead to increased delinquency and default rates by the end of the year.
Citi’s chief financial officer, Mark Mason, pointed out that issues seem to be concentrated among lower-income consumers, who have seen their savings diminish since the pandemic.
Despite the overall resilience of U.S. consumers, Mason noted a disparity in performance across different income groups. “Only the highest income quartile has more savings than they did at the beginning of 2019,” he said, indicating that higher income consumers are driving spending growth, while those with lower credit scores may face greater financial strain.
The Federal Reserve continues to maintain interest rates at a 23-year peak of 5.25-5.5%, awaiting signs of inflation stabilization before considering any rate cuts.
Although banks are bracing for an increase in defaults in the latter half of the year, current data does not indicate a significant consumer crisis. Mulberry observed a division between homeowners and renters from the pandemic period, noting that homeowners benefited from locking in low fixed rates on their debt.
In contrast, renters, who could not secure such favorable rates, are reportedly feeling more financial pressure due to rising rents and inflation. Between 2019 and 2023, rents nationwide increased by over 30%, while grocery costs rose by 25%, impacting those whose wages have not kept pace.
For the time being, according to Narron, the recent earnings reports did not reveal any new issues regarding asset quality. Strong revenues and resilient net interest income continue to indicate a healthy banking sector. Mulberry added that while the banking sector remains robust, extended periods of high interest rates could increase stress on financial institutions.