With interest rates at their highest in over two decades and inflation pressuring consumers, big banks are gearing up to face increased risks from their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all raised their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks set aside to cover potential losses from credit risks, including bad debts and lending like commercial real estate loans.
JPMorgan increased its provision for credit losses to $3.05 billion in the second quarter; Bank of America set aside $1.5 billion; Citi’s allowance for credit losses reached $21.8 billion, more than tripling from the previous quarter; and Wells Fargo allocated $1.24 billion.
These increased reserves indicate banks are preparing for a riskier environment where both secured and unsecured loans could lead to greater losses. A New York Fed analysis of household debt reported that Americans collectively owe $17.7 trillion on consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also climbing as pandemic-era savings dwindle and reliance on credit grows. Credit card balances totaled $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where cardholder balances exceeded the trillion-dollar mark, according to TransUnion. Commercial real estate remains in a precarious position.
“We’re still emerging from the COVID era, especially in banking and consumer health, heavily influenced by the stimulus directed at consumers,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any significant issues for banks are anticipated in the coming months.
“The provisions seen each quarter don’t necessarily reflect recent credit quality but what banks anticipate for the future,” commented Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
In the near term, banks forecast slowed economic growth, higher unemployment, and two interest rate cuts later this year, in September and December, Narron said. This could result in increased delinquencies and defaults by year-end.
Citi’s chief financial officer Mark Mason highlighted that financial challenges appear concentrated among lower-income consumers, whose savings have diminished since the pandemic.
“While we continue to see a resilient U.S. consumer overall, there is a divergence in performance and behavior across FICO scores and income bands,” Mason stated. “Only the highest income quartile has more savings than at the beginning of 2019, and over-740 FICO score customers are driving spending and maintaining high payment rates. Lower FICO score customers are experiencing sharper drops in payment rates and borrowing more due to the acute impact of high inflation and interest rates.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation measures toward the 2% target before implementing the anticipated rate cuts.
Even as banks brace for increased defaults in the latter part of the year, defaults have not yet risen to a level indicating a consumer crisis, Mulberry noted. He is monitoring how the situation unfolds for homeowners compared to renters post-pandemic.
“Homeowners locked in very low fixed rates during the pandemic, insulating them somewhat from current high rates,” Mulberry explained. “Renters, on the other hand, missed out on this opportunity and now face rent increases exceeding wage growth.”
Rents have risen over 30% nationwide between 2019 and 2023, and grocery costs by 25%, straining renters’ budgets, according to Mulberry.
For now, the main takeaway from the latest earnings reports is the stability in asset quality, Narron said. Strong revenues, profits, and resilient net interest income suggest the banking sector remains healthy.
“There’s strength in the banking sector that, while not unexpected, is reassuring, indicating that the financial system structures remain solid,” Mulberry concluded. “However, prolonged high interest rates will continue to cause stress.”