As interest rates hover at highs not seen in over two decades and inflation pressures consumers, major banks are gearing up for increased risks in their lending operations.
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 funds set aside by banks to cover potential losses stemming from credit risk, such as delinquent debt and lending associated with commercial real estate.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s credit loss reserves rose significantly, totaling $21.8 billion—a substantial increase from the prior quarter—and Wells Fargo recorded provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a tougher economic environment, where both secured and unsecured loans could lead to larger losses. A recent report from the New York Federal Reserve highlights that American households collectively hold $17.7 trillion in various forms of debt, including consumer and student loans, alongside mortgages.
There is also a notable rise in credit card issuance and delinquency rates, as consumers exhaust pandemic-era savings and turn to credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter with balances exceeding a trillion dollars, according to TransUnion. The commercial real estate sector also continues to face challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the current banking landscape, noting that consumer health was initially supported by substantial stimulus measures during the pandemic.
However, potential issues for banks may become apparent in the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, explained that quarterly provisions do not necessarily reflect credit quality over the past three months but rather what banks anticipate for the future.
He pointed out that the current economic outlook predicts slowing growth, rising unemployment, and anticipated interest rate cuts in September and December, suggesting an uptick in delinquencies and defaults toward the year’s end.
Citi’s chief financial officer, Mark Mason, highlighted that the identified risks appear concentrated among lower-income consumers, who have seen their savings diminish since the pandemic began.
“While we continue to see an overall resilient U.S. consumer, we also observe a divergence in performance and behavior across different income levels,” Mason stated during an analyst call. He noted that only the highest-income group has managed to increase savings since early 2019, and that customers with higher credit scores are primarily responsible for growth in spending and consistent repayment rates. Conversely, those with lower credit scores are borrowing more and experiencing declines in payment rates, significantly impacted by high inflation and interest rates.
The Federal Reserve maintains interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation measures towards the central bank’s 2% target before implementing anticipated rate cuts.
Despite banks bracing for increased defaults in the latter part of the year, current rates of default do not suggest an impending consumer crisis, according to Mulberry. He noted the divide between homeowners during the pandemic and renters, stating that while rates have risen sharply, homeowners benefited from low fixed-rate debt and are not feeling as much financial strain. In contrast, renters have faced over a 30% rise in rents between 2019 and 2023, along with significant increases in grocery costs, putting more pressure on their budgets.
For the moment, the key insight from the latest earnings reports is that there have been no new issues with asset quality. Strong revenue, profits, and resilient net interest income are reassuring signs of a robust banking sector. Mulberry expressed relief at the ongoing strength of the financial system but cautioned that prolonged high interest rates could lead to increased stress on consumer finances.