With interest rates reaching their highest levels in over 20 years and inflation putting pressure on consumers, major banks are bracing for potential risks in their lending practices.
In the second quarter of the year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. This provision is a financial buffer that banks maintain to cover possible losses from credit risks, which include delinquent debts and lending activities, particularly in commercial real estate.
Specifically, JPMorgan allocated $3.05 billion for credit losses during the quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance exceeded expectations, reaching $21.8 billion at the end of the quarter, more than tripling its reserves from the previous quarter. Wells Fargo reported provisions of $1.24 billion.
The buildup of these reserves indicates that banks are preparing for a challenging lending environment, where both secured and unsecured loans may lead to larger losses. A recent study by the New York Federal Reserve revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, the issuance of credit cards and corresponding delinquency rates are rising as many consumers exhaust their pandemic-era savings and increasingly turn to credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where the total exceeded a trillion dollars. Moreover, the commercial real estate sector continues to exhibit vulnerabilities.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the ongoing impact of the COVID-19 pandemic on banking and consumer health, attributing much of it to the stimulus support previously provided to consumers.
Challenges for banks are anticipated in the upcoming months. Mark Narron, a senior director at Fitch Ratings, emphasized that current provisions do not solely reflect past credit quality, but rather the banks’ expectations for future performance.
Banks are currently forecasting slower economic growth, increased unemployment rates, and possible interest rate cuts later this year. This outlook suggests a likelihood of rising delinquencies and defaults as the year progresses.
Citi’s Chief Financial Officer Mark Mason flagged that concerns are particularly pronounced among lower-income consumers, who have seen their savings diminish since the pandemic began.
Mason pointed out that while the overall U.S. consumer remains resilient, there is a significant disparity based on income level and credit scores. Notably, only the highest income quartile has managed to save more than they had at the start of 2019, with spending growth primarily driven by consumers with FICO scores over 740. Conversely, consumers with lower credit scores have been accumulating more debt and experiencing significant drops in payment rates, largely due to the pressures of inflation and rising interest rates.
The Federal Reserve currently maintains interest rates at a historic high of 5.25-5.5%, holding off on rate cuts until inflation approaches its 2% target.
Despite preparations for increased defaults later in the year, Mulberry noted that current default rates do not indicate an impending consumer crisis. He is particularly monitoring the differences between homeowners and renters who lived through the pandemic.
While interest rates have risen significantly, homeowners who locked in low fixed rates prior to these increases have largely avoided financial strain. Conversely, renters have faced substantial hikes in rent—over 30% nationwide from 2019 to 2023—and a 25% rise in grocery costs, leading to greater stress on their budgets.
For now, the latest earnings reports suggest stability in the banking sector, with no alarming new developments regarding asset quality. Narron noted positive indicators including strong revenues and profits. Mulberry affirmed that, despite some encouraging signs of strength in the banking sector, ongoing high interest rates will inevitably lead to more pressure in the future.