As interest rates remain at their highest levels in over 20 years and inflation continues to affect consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, top financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds set aside to account for potential losses resulting from credit risk, including defaults on loans and delinquent accounts, particularly in commercial real estate.
JPMorgan reported a provision for credit losses of $3.05 billion, while Bank of America allocated $1.5 billion. Citigroup’s allowance reached $21.8 billion—more than triple its build from the previous quarter—and Wells Fargo designated $1.24 billion for similar purposes.
These increased reserves indicate that banks are preparing for a more challenging lending environment where both secured and unsecured loans could lead to significant losses. The New York Federal Reserve recently revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance is rising, and delinquency rates are also climbing as consumers deplete their savings accumulated during the pandemic and increasingly rely on credit. Credit card debt reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter in which total credit card balances surpassed the trillion-dollar milestone, according to TransUnion. Additionally, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the ongoing recovery from the pandemic, emphasizing the importance of stimulus measures implemented for consumer support.
However, challenges for banks may loom in the future. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that quarterly provisions do not necessarily reflect recent credit quality; rather, they are predictive of future expectations.
Banks are currently anticipating slower economic growth, a potential rise in unemployment, and two interest rate cuts expected in September and December, which may lead to more delinquent accounts and defaults as the year progresses.
Mark Mason, chief financial officer at Citigroup, identified concerning trends, particularly among lower-income consumers who have seen their savings diminish post-pandemic. He highlighted a growing disparity in financial performance based on income and credit scores.
Mason emphasized that, while the overall U.S. consumer appears resilient, only the top income quartile has more savings than before 2019. He noted that customers with higher credit scores are driving spending growth, whereas those with lower scores are experiencing more substantial drops in payment rates and increasing reliance on credit amid high inflation and interest rates.
The Federal Reserve has maintained interest rates between 5.25% and 5.5%, the highest in 23 years, as it aims to stabilize inflation around its 2% target before implementing anticipated rate cuts.
Despite banks preparing for potential defaults in the latter half of the year, current default rates do not indicate a consumer crisis, according to Mulberry. He pointed out that homeowners who locked in low fixed rates during the pandemic are not feeling the same financial pressure as renters, who have faced significant rent increases and rising grocery costs since 2019.
In summary, current earnings from banks indicate stable asset quality, with strong revenues and profits suggesting a healthy banking sector. Mulberry remarked that the strength of the financial system remains intact, though continuous high interest rates are likely to cause increasing stress over time.