As interest rates reach their highest levels in more than 20 years and inflation continues to impact consumers, major banks are bracing for potential risks associated with 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 are funds that banks set aside to cover potential losses from credit risk, including bad debt and commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s total allowance for credit losses reached $21.8 billion by the end of the quarter, significantly more than its previous quarter’s provisions, and Wells Fargo provisions came to $1.24 billion.
These increased provisions suggest that banks are preparing for a more challenging environment, where both secured and unsecured loans could lead to greater losses. The New York Fed recently reported that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as consumers draw down their pandemic-era savings and increasingly rely on credit. Credit card balances surpassed $1 trillion for the second consecutive quarter, highlighting consumer borrowing trends.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted the lingering effects of the COVID era on banking and consumer health, attributing some consumer resilience to stimulus measures that were introduced.
However, any forthcoming challenges for banks may manifest in the months ahead. Mark Narron, a senior director with Fitch Ratings, explained that the provisions reported each quarter do not reflect actual credit quality over the past three months but rather the banks’ outlook for the future. He pointed out a shift in how provisions are determined, which now often correlates more closely with macroeconomic expectations rather than solely on loan performance.
In the short term, banks are forecasting a slowdown in economic growth, a rise in unemployment rates, and two anticipated interest rate cuts later this year. This outlook may lead to increased delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, observed that indicators of concern are particularly evident among lower-income consumers, whose savings have significantly diminished since the pandemic. While there remains an overall resilience among U.S. consumers, Mason highlighted a disparity in financial behavior across different income levels.
He pointed out that only the highest income quartile has maintained more savings than before 2019, with customers holding credit scores above 740 driving spending growth. In contrast, those at lower FICO levels are experiencing stark declines in payment rates and are borrowing more due to inflated living costs.
The Federal Reserve has maintained a 23-year high interest rate of 5.25-5.5%, waiting for inflation to stabilize closer to its 2% target before considering any rate cuts.
Despite banks preparing for potential defaults later this year, current default rates do not indicate a consumer crisis, according to Mulberry. He noted the distinction between homeowners and renters during the pandemic, with homeowners benefiting from low fixed rates, thus feeling less financial pressure compared to renters facing rising costs.
With rents increasing over 30% nationwide and grocery prices up 25% between 2019 and 2023, renters who did not secure low rates are facing the most financial strain.
Overall, the latest earnings reports show that there were no significant new concerns regarding asset quality. Strong revenues, profits, and healthy net interest income indicate a robust banking sector, according to Narron. Mulberry affirmed the stability of the financial system while cautioning that prolonged high interest rates could lead to increased stress.