As interest rates remain at their highest levels in over two decades and inflation continues to burden consumers, major banks are bracing 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 designed to cover potential losses from credit risk, including overdue debts and lending issues, 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 for credit losses reached $21.8 billion by the end of the quarter, more than tripling its reserve buildup from the previous quarter. Wells Fargo established provisions totaling $1.24 billion.
These increased provisions indicate that banks are preparing for a more challenging environment where both secured and unsecured loans could lead to greater losses. A recent report from the New York Fed revealed that Americans are collectively in debt for $17.7 trillion across consumer loans, student loans, and mortgages.
Moreover, the issuance of credit cards and delinquency rates are rising as consumers deplete their pandemic-era savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter in which total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. Commercial real estate is also facing challenges.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking sector’s outlook remains uncertain as it continues to recover from the impacts of COVID-19, particularly concerning consumer health and the effects of previously deployed stimulus funds.
Issues facing banks are expected to manifest in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported each quarter do not always reflect the immediate credit quality but rather what banks anticipate will happen in the future. He noted a shift from a historical approach, where increasing defaults would drive up provisions, to one that is heavily influenced by macroeconomic forecasts.
In the short term, banks are predicting slower economic growth, higher unemployment, and two potential interest rate cuts in September and December. These developments could lead to an uptick in delinquencies and defaults as the year concludes.
Citigroup’s CFO Mark Mason highlighted that the signs of trouble are especially evident among lower-income consumers, who have seen their financial buffers decrease since the pandemic. He pointed out a growing divide in consumer behaviors across different income levels, with only the highest income quartile maintaining increased savings since early 2019.
Currently, the Federal Reserve has maintained interest rates between 5.25% and 5.5%, a 23-year high, as it awaits stabilization in inflation towards its 2% target before implementing anticipated rate cuts.
Despite banks’ preparations for a wave of defaults, Mulberry noted that current default rates do not indicate a consumer crisis. He is particularly observing the distinction between homeowners and renters during the pandemic. Homeowners who secured low fixed-rate mortgages are not experiencing the same financial strain as renters, who are facing significant increases in housing costs without the benefit of low rates.
Between 2019 and 2023, rents have surged more than 30% nationally, along with a 25% rise in grocery prices, putting considerable pressure on renters who cannot match wage growth.
For now, the latest earnings report underscores that there are no new concerns regarding asset quality. Strong revenues, profits, and solid net interest income suggest a continued stability within the banking sector. Mulberry remarked that while there are positive signs in the financial system, the prolonged high interest rates may eventually create stress that warrants close monitoring.