As interest rates reach their highest levels in over two decades and inflation continues to impact consumers, major banks are preparing for increased risks associated with their lending activities.
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 that banks set aside to cover potential losses linked to credit risk, including bad debt and loans, particularly in commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance rose to $21.8 billion, significantly increasing its reserves from the prior quarter, and Wells Fargo provisioned $1.24 billion.
These reserve increases indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans may lead to larger losses for some of the nation’s largest financial institutions. A recent report by the New York Federal Reserve revealed that American households owe a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also climbing as individuals deplete their pandemic savings and increasingly depend on credit. In the first quarter, total credit card balances reached $1.02 trillion, marking the second consecutive quarter where total cardholder debt surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also remains vulnerable.
“We’re still emerging from the COVID era, particularly regarding banking and consumer health, where stimulus played a significant role,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any challenges for banks are expected in the upcoming months. “The provisions reflect not just past credit quality, but banks’ expectations of what might unfold in the future,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
Currently, banks anticipate slower economic growth, higher unemployment, and potential interest rate cuts later this year, which could contribute to increased delinquencies and defaults.
Citigroup’s chief financial officer, Mark Mason, noted that concerns mainly pertain to lower-income consumers, who have seen their savings diminish since the pandemic. “While the U.S. consumer appears generally resilient, there is noticeable variation in performance across different income levels,” he stated during an analysts’ call.
He pointed out that only the highest income quartile has retained more savings than before 2019 and that customers with high credit scores are primarily driving spending growth and maintaining strong payment rates. In contrast, those with lower credit scores are experiencing steep declines in payment rates and are borrowing more due to the effects of high inflation and interest rates.
The Federal Reserve maintains interest rates at a 23-year peak of 5.25-5.5%, awaiting stabilization of inflation rates towards the bank’s 2% target before considering rate cuts.
Despite banks bracing for increased defaults later this year, Mulberry believes that defaults are not rising at a level that signals a consumer crisis. He contrasts the situation of mortgage-holding homeowners with that of renters. “While rates have significantly increased, homeowners secured lower fixed rates, so their financial burden remains manageable,” he explained. “Meanwhile, renters who didn’t benefit from low rates are facing mounting pressures, with rents rising sharply and grocery costs up 25% from 2019 to 2023.”
Overall, the recent earnings reports indicate no new issues regarding asset quality, with robust revenues, profits, and strong net interest income suggesting a healthy banking sector. “There are signs of strength in the banking system that, while not unexpected, are reassuring and suggest the financial structures remain solid at this time,” Mulberry said. He cautioned, however, that prolonged high interest rates will increase stress on the system.