As interest rates reach their highest levels in over two decades and inflation pressures 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 all increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside to cover potential losses from credit risks, including delinquent loans and commercial real estate loans.
Specifically, JPMorgan increased its provision for credit losses by $3.05 billion; Bank of America set aside $1.5 billion; Citigroup’s allowance for credit losses grew to $21.8 billion, which is more than three times its previous quarter’s credit reserve; and Wells Fargo allocated $1.24 billion for the same purpose.
These increased provisions indicate that banks are bracing for a potentially riskier lending environment, where both secured and unsecured loans may result in larger losses. A recent analysis from the New York Federal Reserve revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance is on the rise alongside delinquency rates, as consumers begin to exhaust their savings accumulated during the pandemic and increasingly rely on credit. In the first quarter of this year, total credit card balances reached $1.02 trillion, marking the second consecutive quarter where balances surpassed the trillion-dollar mark, according to TransUnion. The commercial real estate sector remains under significant pressure as well.
“We are still emerging from the COVID era, and a lot of the consumer interaction was influenced by the stimulus provided,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, analysts warn that any negative impact on banks may manifest in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported by banks may not reflect their recent credit quality but rather their expectations for future conditions.
It’s noteworthy that there has been a shift towards a model where macroeconomic forecasts largely dictate provisioning, rather than just the performance of bad loans.
Currently, banks anticipate slowing economic growth, higher unemployment rates, and two potential interest rate cuts later this year, which could lead to increased delinquencies and defaults.
Citi’s chief financial officer Mark Mason highlighted concerns about lower-income consumers who have seen their savings diminish since the pandemic. While the overall U.S. consumer remains resilient, there is significant variance in performance across different income and credit score levels. He noted that only the highest income quartile has retained more savings than at the beginning of 2019, and individuals with higher credit scores are the ones driving spending growth.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation measures towards a 2% target before implementing the expected rate cuts.
Despite banks preparing for potential defaults, Mulberry noted that current rates of defaults do not yet suggest a consumer crisis. He is particularly observing the dynamics between homeowners and renters, as homeowners generally secured low fixed rates during the pandemic, while renters are facing significant price increases in housing.
Rents have risen over 30% nationwide between 2019 and 2023, and grocery bills have increased by 25% during the same period, placing considerable strain on renters who have not locked in lower rates and whose income growth has not kept pace with rising costs.
For now, the latest earnings reports indicate that there have been no significant changes in asset quality, with strong revenues and profits indicating a healthy banking sector. Mulberry emphasized that the financial system remains robust, although prolonged high-interest rates may introduce additional stress in the future.