With interest rates at their highest in over two decades and inflation pressuring consumers, major banks are poised to encounter increased risks from 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 represent funds set aside by banks to cover potential losses from credit risks, including overdue loans and commercial real estate (CRE) lending.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the quarter’s end, marking more than a threefold increase from the prior quarter. Wells Fargo also had provisions totaling $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans may lead to larger losses. According to the New York Federal Reserve, American households collectively owe $17.7 trillion in consumer, student, and mortgage loans.
Furthermore, credit card issuance and delinquency rates are rising as individuals deplete their pandemic-era savings and turn increasingly to credit. In the first quarter, credit card balances surpassed $1.02 trillion for the second consecutive quarter, according to TransUnion. CRE continues to face challenges as well.
“We’re still emerging from the COVID era, especially in terms of banking and consumer health, which were significantly influenced by the stimulus provided to consumers,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any challenges faced by banks are expected to materialize in the coming months.
“The provisions reflected in any given quarter do not necessarily indicate credit quality for the last three months; they are based on what banks anticipate for the future,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
He noted a shift from a historical approach—where rising defaults led to increased provisions—to a model more dependent on macroeconomic forecasts.
In the short term, banks anticipate slower economic growth, rising unemployment rates, and two interest rate cuts later this year, which could lead to more delinquencies and defaults as the year ends.
Citi’s chief financial officer Mark Mason pointed out that concerns are particularly relevant for lower-income consumers whose savings have dwindled since the pandemic.
“While we see an overall resilient U.S. consumer, we’re also observing a performance divergence based on income and credit scores,” Mason told analysts. “Only the highest income quartile has increased their savings since early 2019, and it is primarily those with a FICO score over 740 driving spending growth and maintaining high repayment rates. In contrast, lower FICO customers are experiencing significant declines in payment rates and are borrowing more due to the impact of high inflation and interest rates.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% while awaiting stability in inflation measures towards its 2% goal before implementing anticipated rate cuts.
Despite banks bracing for potential defaults later in the year, Mulberry noted that defaults are not currently rising at a rate indicative of a consumer crisis. He is particularly observing the differences between homeowners and renters from the pandemic period.
“While rates have increased significantly since then, homeowners locked in low fixed rates on their debt and are not feeling the burden as acutely,” Mulberry commented. “In contrast, renters who could not take advantage of these rates are facing substantial challenges.”
Over the past few years, rents have surged over 30% nationwide, and grocery costs have increased by 25%. Renters unable to secure low rates are experiencing pressure on their monthly budgets.
For now, one key takeaway from the latest earnings reports is that “there was nothing surprising this quarter in terms of asset quality,” according to Narron. Strong revenues, profits, and robust net interest income suggest a healthy banking sector.
“There remains strength in the banking sector, which was somewhat expected, but it’s reassuring to see that the financial system’s structures remain strong and sound at this time,” Mulberry remarked. “However, we are monitoring the situation closely; prolonged high interest rates could lead to increased stress.”