As interest rates reach their highest levels in over 20 years and inflation continues to impact consumers, major banks are bracing for potential risks related to their lending practices.
In the second quarter, 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 banks allocate to cover possible losses from credit risks, which include delinquent accounts and bad debts related to lending practices, including commercial 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 rose to $21.8 billion by the end of the quarter, more than tripling its reserve from the prior quarter, and Wells Fargo had provisions amounting to $1.24 billion.
These increases indicate that banks are preparing for a more challenging economic environment, where both secured and unsecured loans may result in greater losses for these financial institutions. According to a recent analysis by the New York Fed, U.S. households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance is also on the rise, with delinquency rates climbing as people exhaust their pandemic-era savings and turn increasingly to credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that total balances have surpassed the trillion-dollar threshold, as reported by TransUnion. Additionally, the commercial real estate sector remains under pressure.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted the ongoing impacts of the COVID era on banking and consumer health, emphasizing the considerable stimulus that was provided during this time.
However, potential challenges for banks may be on the horizon. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that the provisions reflected in quarterly reports often do not directly correlate to recent credit quality, but instead forecast what banks expect will occur in the future.
In the near term, banks predict slowing economic growth, higher unemployment rates, and anticipate interest rate cuts later this year, which could lead to increased delinquencies and defaults.
Citi’s chief financial officer Mark Mason observed that warning signs appear more prominent among lower-income consumers, who have seen their savings diminish since the pandemic.
“While we still see a resilient U.S. consumer overall, there is significant variation in performance and behavior based on credit scores and income levels,” Mason stated in a recent analyst call. He highlighted that only the highest income quartile has maintained more savings than before 2019, with high-FICO score customers driving spending growth. In contrast, those with lower credit scores are experiencing declines in payment rates and increased borrowing, as they are hit hardest by rising inflation and interest rates.
The Federal Reserve currently maintains interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation towards its 2% target before implementing anticipated rate cuts.
Despite preparations for increased defaults later this year, current default rates do not indicate a consumer crisis, according to Mulberry. He is particularly monitoring the difference in experiences between homeowners and renters during the pandemic.
“While rates have risen significantly, homeowners locked in low fixed rates, and as a result, they are not feeling the financial strain as much. Renters missed that opportunity,” he explained.
With rents having surged over 30% nationally from 2019 to 2023, alongside a 25% increase in grocery costs, those who did not secure low rates are facing considerable monthly budget pressure.
Currently, the overall message from the latest earnings reports is that there are no significant new concerns regarding asset quality. Strong revenue, profits, and robust net interest income are encouraging signs of a healthy banking sector.
“There’s a resilience in the banking sector that is somewhat reassuring. While this stability isn’t entirely unexpected, it is a relief to see that the foundations of the financial system remain solid,” Mulberry concluded. “However, we remain vigilant, as prolonged high-interest rates could introduce further stress on the system.”