As interest rates reach peaks not seen in over two decades and inflation continues to impact consumers, major banks are bracing for increased risks stemming from their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all boosted their provisions for credit losses compared to the previous quarter. These provisions are funds set aside by financial institutions to address potential losses from credit risks, including overdue debts and lending, particularly in commercial real estate.
Specifically, JPMorgan allocated $3.05 billion towards credit loss provisions in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s total credit loss allowance reached $21.8 billion—more than tripling its reserved funds from the previous quarter. Wells Fargo contributed $1.24 billion to its provisions.
The increase in provisions indicates that banks are preparing for a more challenging environment, where both secured and unsecured loans may lead to significant losses. A recent report from the New York Fed disclosed that Americans collectively owe $17.7 trillion in various forms of debt, including consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are climbing, as consumers exhaust their pandemic-era savings and increasingly rely on credit. Credit card balances rose to $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total credit card balances surpassed one trillion dollars, according to TransUnion. Moreover, commercial real estate remains in a precarious state.
“We are still emerging from the COVID era,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management, emphasizing the effect of government stimulus on consumer health.
Experts suggest that the real challenges for banks will materialize in the upcoming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, noted that the provisions observed in any given quarter do not solely reflect recent credit quality but also anticipated future conditions.
A slowdown in economic growth and potential interest rate cuts later this year could lead to increased delinquency rates and defaults, according to Narron. He pointed out that these warning signs are more prevalent among lower-income consumers, who have depleted their savings since the pandemic began.
Citigroup’s CFO, Mark Mason, reiterated this point, highlighting a disparity between different income levels and credit profiles among consumers. He indicated that only the wealthiest quartile has managed to save more than they had at the start of 2019, with consumers having higher credit scores driving spending growth. Conversely, those in lower credit score brackets are showing declines in payment rates and increased borrowing.
The Federal Reserve has maintained interest rates in a range of 5.25% to 5.5%, the highest in 23 years, as it awaits inflation to stabilize at its 2% target before considering rate cuts.
Currently, despite banks preparing for higher default rates later in the year, actual defaults are not escalating to the level indicative of a consumer crisis, according to Mulberry. He is particularly monitoring the impact on homeowners compared to renters, noting that many homeowners locked in low fixed mortgage rates and may not feel immediate financial pressure.
In contrast, renters, who did not take advantage of low rates and are facing skyrocketing rents—over 30% from 2019 to 2023—alongside a 25% increase in grocery costs, are experiencing significant strain in their budgets.
Overall, the recent earnings reports suggest that there are no significant new issues concerning asset quality. Positive indicators, including strong revenue and profits, point to a resilient banking sector, as Mulberry remarked on the stability within the financial system. However, he cautioned that prolonged high-interest rates could lead to mounting stress.