As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are preparing for increased risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their provisions for credit losses compared to the previous quarter. These provisions represent funds that financial institutions set aside to cover potential losses from credit risks, including delinquent debts and real estate 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 reached $21.8 billion by the end of the quarter, more than tripling its reserves from the previous quarter. Wells Fargo recorded provisions of $1.24 billion.
These financial reserves indicate that banks are bracing for a more challenging environment where both secured and unsecured loans could result in larger losses. A recent analysis by the New York Fed revealed that American households carry a collective debt of $17.7 trillion in consumer loans, student loans, and mortgages.
The rise in credit card issuance and delinquency rates is noteworthy, as consumers are beginning to deplete their pandemic-era savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where the cumulative balance exceeded one trillion dollars. The commercial real estate market also remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked on the ongoing challenges in banking and consumer health, attributing them to the stimuli distributed to consumers during the pandemic.
Experts indicate that any potential problems for banks will manifest in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported each quarter do not solely reflect recent credit quality; they are indicative of banks’ expectations for future conditions.
Narron noted a shift from a historical model where rising bad loans drove increased provisions, to one where macroeconomic forecasts heavily influence provisioning decisions. In the near future, banks anticipate sluggish economic growth, rising unemployment, and potential interest rate cuts in September and December, which could lead to more delinquencies and defaults as the year concludes.
Citigroup’s CFO Mark Mason highlighted concerning trends among lower-income consumers, who have seen their savings shrink significantly since the pandemic. He acknowledged that while overall consumer resilience appears strong, there is a noticeable performance divergence based on income levels and credit scores.
Currently, only the highest-income earners have maintained savings above pre-2019 levels, with those boasting credit scores over 740 driving spending growth and keeping payment rates high. In contrast, lower credit score customers are facing declines in payment rates and are borrowing more due to the pressures of high inflation and interest rates.
The Federal Reserve’s decision to maintain interest rates at a 23-year high of 5.25-5.5% reflects an effort to stabilize inflation toward the central bank’s 2% target before implementing any anticipated rate cuts.
Despite preparations for possible defaults, experts report that consumer defaults have not yet risen to alarming levels. Mulberry is particularly observing the differences between homeowners from the pandemic era and renters. Although interest rates have surged, homeowners have been able to lock in low fixed rates, shielding them from significant financial strain. In contrast, renters—facing a 30% increase in rents since 2019 and a 25% rise in grocery costs—are experiencing considerable stress as their expenses outpace wage growth.
For now, the overall earnings show no new concerns regarding asset quality. Strong revenues and profits indicate a resilient banking sector. Mulberry emphasized that the stability of the financial system is reassuring, but the prolonged high-interest rates could lead to increased stress in the future.