With interest rates reaching over two-decade highs and inflation continuing to impact consumers, major banks are preparing for potential risks associated with their lending activities.
In the second quarter, leading financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo reported an increase in provisions for credit losses compared to the previous quarter. These provisions are funds set aside to cover potential losses resulting from credit risks, including unpaid debts and lending, particularly in commercial real estate (CRE).
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, reflecting a significant increase from the prior quarter, and Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves indicate that banks are preparing for a more uncertain environment where both secured and unsecured loans could lead to larger losses. A recent analysis from the New York Fed revealed that Americans now owe a total of $17.7 trillion in consumer, student, and mortgage loans.
Additionally, credit card issuance and delinquency rates are climbing as individuals deplete their pandemic-era savings and increasingly rely on credit. Credit card balances topped $1.02 trillion in the first quarter, marking the second consecutive quarter of exceeding the trillion-dollar threshold, according to TransUnion. The commercial real estate sector remains vulnerable as well.
“We are still emerging from the COVID era, particularly regarding banking and consumer health, which was significantly influenced by the stimulus provided to consumers,” commented Brian Mulberry, a portfolio manager at Zacks Investment Management.
However, the true impact on banks is expected to manifest in the coming months. Mark Narron, a senior director at Fitch Ratings, pointed out that current provisions do not merely reflect past credit quality but rather banks’ anticipations for the future.
“There has been a shift from a traditional approach where provisions increased with loan defaults, to one where macroeconomic forecasts play a crucial role in determining provisioning,” he stated.
Looking ahead, banks foresee slowing economic growth, a rise in unemployment, and possible interest rate cuts later this year in September and December, all of which could lead to increased delinquencies and defaults by year-end.
Citi’s chief financial officer, Mark Mason, highlighted that these risks are particularly pronounced among lower-income consumers, who have seen their savings shrink since the pandemic.
“While the overall U.S. consumer remains resilient, we observe a divergence in behavior across income bands and credit scores,” Mason mentioned during an analyst call. “Only the highest income quartile has more savings than they did at the start of 2019, with higher credit score customers contributing to spending growth and maintaining solid payment rates. Conversely, lower credit score customers are experiencing significant drops in payment rates and increased borrowing as they face the pressures of high inflation and interest rates.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation rates towards its 2% target before implementing anticipated cuts.
Despite banks’ preparations for escalating defaults in the latter part of the year, Mulberry indicated that defaults have not yet risen to levels indicating a consumer crisis. He noted the distinction between homeowners and renters during the pandemic, stating, “While interest rates have surged, homeowners secured low fixed rates, mitigating their financial pain, unlike renters who lacked that opportunity.”
With rents soaring over 30% nationwide and grocery costs climbing 25% between 2019 and 2023, renters are experiencing heightened financial strain, as their budgets are not keeping pace with rising living costs.
Nevertheless, the key takeaway from the recent earnings reports is the stability of asset quality. “Nothing new emerged this quarter concerning asset quality,” Narron remarked, noting strong revenues and profits, which are encouraging signs for the health of the banking sector.
“There is some strength in the banking sector that was perhaps not entirely unexpected, but it’s reassuring to see that the structures of our financial system remain robust,” Mulberry concluded. “However, the long-term effects of prolonged high-interest rates will continue to be a point of concern.”