As interest rates remain at their highest levels in over 20 years and inflation continues to pressure 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 raised their provisions for credit losses compared to the previous quarter. These provisions are the reserves banks set aside to cover potential losses from credit risk, including bad debt and commercial real estate loans.
JPMorgan increased its provision for credit losses to $3.05 billion, while Bank of America reported $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, more than tripling its previous quarter’s reserve buildup. Wells Fargo set aside $1.24 billion for provisions.
This accumulation of reserves indicates that banks are anticipating a more challenging environment, where both secured and unsecured loans could lead to greater losses. A recent report from the New York Fed highlighted that Americans owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as consumers exhaust their pandemic-era savings and depend more on credit. TransUnion reported that total credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter that balances surpassed the trillion-dollar milestone. Additionally, commercial real estate continues to face significant concerns.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented, “We’re still coming out of this COVID era, and mainly regarding banking and consumer health, it was all the stimulus that was deployed to the consumer.”
Experts warn that potential issues for banks may surface in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that current provisions reflect banks’ expectations for the future rather than past credit quality. He explained that the trend has shifted from a reactive provisioning model to one driven by macroeconomic forecasts.
Banks are currently forecasting sluggish economic growth, a rise in unemployment, and two interest rate cuts anticipated for September and December, suggesting that delinquencies and defaults could rise by the end of the year.
According to Citi CFO Mark Mason, these warning signs are mostly found among lower-income consumers, who have seen their savings diminish since the pandemic began. He mentioned that while the overall U.S. consumer appears resilient, there are disparities in financial behavior based on income and credit scores. Higher-income consumers have shown increased savings compared to lower-income individuals, who are facing challenges due to high inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation towards its 2% target before implementing expected rate cuts.
Despite banks preparing for potential defaults, current rates of default do not indicate an impending consumer crisis, according to Mulberry. He emphasizes the distinction between homeowners and renters during this period. Homeowners benefitted from locking in low fixed rates, while renters are facing significant cost challenges with rising rents and grocery prices.
Overall, the latest earnings reports indicated no significant new issues with asset quality. Strong revenues, profits, and resilient net interest income suggest that the banking sector remains robust. Mulberry highlighted that while the financial system remains strong, prolonged high interest rates could lead to increased stress on both consumers and banks.