As interest rates reach levels not seen in over two decades and inflation puts pressure on 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 reserves for credit losses compared to the previous quarter. These reserves represent the funds banks allocate to cover potential losses from credit risks, such as overdue loans and bad debts, including commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America reported $1.5 billion. Citigroup’s credit loss reserves reached $21.8 billion by the end of the quarter, more than tripling its previous quarter’s reserves, and Wells Fargo accounted for $1.24 billion in provisions.
These increased reserves indicate that financial institutions are preparing for a more precarious economic environment where both secured and unsecured loans could lead to greater losses. A recent report from the New York Federal Reserve estimated that total household debt in the U.S. stands at $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
Moreover, there is a noticeable rise in credit card issuance and delinquency rates as Americans deplete their pandemic-era savings and increasingly rely on credit. In the first quarter of this year, credit card balances climbed to $1.02 trillion, marking the second consecutive quarter in which total cardholder balances surpassed the trillion-dollar mark, according to data from TransUnion. The commercial real estate market also remains in a fragile state.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking system is still navigating the aftermath of the COVID-19 pandemic, particularly regarding consumer financial health driven by past stimulus measures.
However, any challenges facing banks may emerge in the foreseeable future. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, highlighted that quarterly provisions don’t solely reflect recent credit quality but are more indicative of banks’ expectations for future conditions.
Currently, banks anticipate a slowdown in economic growth and higher unemployment rates, along with expected interest rate cuts later in the year. This outlook may result in increased delinquency and default rates by year-end.
Citi’s Chief Financial Officer, Mark Mason, remarked that troubling indicators are particularly evident among lower-income consumers, many of whom have seen their savings diminish since the pandemic began. He noted that while overall consumer resilience persists, significant disparities exist in performance across different income and credit score categories.
Only the highest income quartile appears to have maintained more savings than before 2019, and it is predominantly those with FICO scores above 740 who are driving spending growth and maintaining timely payments. In contrast, consumers with lower credit scores are experiencing declines in payment rates and are borrowing more, being disproportionately affected by rising inflation and interest rates.
The Federal Reserve has kept interest rates at a 23-year high of 5.25% to 5.5% as it monitors inflation trends in hopes of achieving its target of 2% before implementing the anticipated rate cuts.
Despite banks preparing for a potential increase in defaults later this year, current default rates do not yet indicate a consumer crisis, according to Mulberry. He emphasizes a notable distinction between homeowners and renters during the pandemic, with homeowners typically securing low fixed rates on their mortgages, insulating them from immediate financial strain.
In contrast, renters have faced a substantial rise in costs, with national rents increasing by over 30% from 2019 to 2023 and grocery prices rising by 25% during that timeframe. These pressures have been particularly challenging for renters whose salaries have not kept pace.
For now, the latest earnings reports reflect that, while there are concerns lingering in the financial landscape, asset quality remains stable. Strong revenues, profits, and net interest income all suggest that the banking sector remains fundamentally sound. Mulberry concluded that, although there are positive signs, ongoing high interest rates could lead to increased stress in the financial system.