As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are gearing up to face increased risks associated with their lending practices.
In the second quarter of the year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks set aside to mitigate potential losses from credit risks, including defaults on loans, such as those in commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit losses during the second quarter; Bank of America raised its provisions to $1.5 billion; Citi’s allowance totaled $21.8 billion, marking more than a threefold increase from the prior quarter; and Wells Fargo recorded provisions of $1.24 billion.
These reserves indicate that banks are preparing for a riskier lending environment, where both secured and unsecured loans may lead to greater losses. A recent analysis by the New York Fed revealed that Americans collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Moreover, credit card issuance and delinquency rates are on the rise as consumers deplete their savings accumulated during the pandemic and increasingly turn to credit. In the first quarter, total credit card balances reached $1.02 trillion, marking the second consecutive quarter where the total surpassed the $1 trillion threshold. Additionally, the CRE sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted, “We’re still emerging from the COVID era, particularly concerning banking and consumer health, which was significantly influenced by stimulus measures provided to consumers.”
However, challenges for banks are expected to materialize in the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, stated that current provisions do not necessarily indicate recent credit quality but are instead a reflection of banks’ future expectations.
“It’s intriguing because we’ve shifted from a model where increasing loan defaults drive up provisions to a scenario where macroeconomic forecasts largely determine provisioning levels,” Narron explained.
In the short term, banks anticipate slowing economic growth, rising unemployment, and anticipated interest rate cuts in September and December, which may lead to more delinquencies and defaults by year-end.
Citi’s chief financial officer Mark Mason highlighted that these troubling trends seem concentrated among lower-income consumers, who have seen their savings diminish since the pandemic.
“While we observe overall resilience in the U.S. consumer, a divergence exists in performance by income level and credit score,” Mason remarked. He noted that only the upper-income quartile has more savings than prior to 2019, with those having credit scores over 740 driving spending growth while lower-FICO score customers experience increased borrowing and declining payment rates due to high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation rates toward its 2% target before proceeding with anticipated rate cuts.
Despite banks bracing for increased defaults later in the year, Mulberry indicated that current default rates do not suggest an imminent consumer crisis. He emphasized the different experiences of homeowners and renters during the pandemic.
“Although rates have risen significantly, homeowners secured low fixed-rate debt, so they are not feeling the impact to the same extent as renters, who have faced substantial rent increases without the benefits of low mortgage rates,” he said.
Rents surged over 30% nationwide from 2019 to 2023, while grocery costs rose 25%, placing significant strain on renters’ budgets who could not secure fixed rates.
Ultimately, the recent earnings reports suggest stability in asset quality, according to Narron. He noted that the robust revenues and profits, along with steady net interest income, reflect a healthy banking sector at present.
“There are positive signals in the banking sector that were somewhat expected. It’s reassuring to see that the financial system remains strong and sound, but we are closely monitoring the situation, as prolonged high interest rates will increase stress,” Mulberry concluded.