With interest rates at their highest levels in over two decades and inflation putting pressure on 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 represent funds set aside by financial institutions to cover potential losses arising from credit risks, which include delinquent debts and loans, such as those related to commercial real estate.
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 by the end of the quarter—more than tripling its reserves from the previous quarter. Wells Fargo’s provisions totaled $1.24 billion.
These increased provisions indicate that banks are preparing for a challenging financial landscape where both secured and unsecured loans may lead to greater losses for some of the largest banking institutions in the country. According to a recent analysis by the New York Fed, Americans currently owe a total of $17.7 trillion in various types of consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are rising as consumers exhaust their pandemic-related savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold, as reported by TransUnion. The commercial real estate sector also remains vulnerable.
“We’re still emerging from the COVID era, and when it comes to banking and consumer health, it all ties back to the stimulus that was provided to consumers,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Challenges for banks are anticipated in the upcoming months. “The provisions reported each quarter do not necessarily reflect credit quality from the past three months; rather, they indicate what banks expect in the future,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group. He noted a shift from a historic model where rising loan defaults prompted increased provisions to one where macroeconomic forecasts dictate provisioning practices.
In the near future, banks predict sluggish economic growth, a rising unemployment rate, and two interest rate cuts later this year, which could lead to an increase in delinquencies and defaults by the year’s end.
Citi’s chief financial officer, Mark Mason, highlighted that these warning signs predominantly affect lower-income consumers, who have seen their savings diminish since the pandemic began. “While we observe resilience among U.S. consumers overall, performance varies significantly across different income and credit scores,” Mason said during a recent analyst call.
“Only the highest income quartile has more savings than they did at the start of 2019, and it is primarily consumers with scores over 740 driving spend growth and maintaining high payment rates,” he noted. In contrast, those with lower credit scores are experiencing more significant declines in payment rates and are borrowing more, exacerbated by high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year peak of 5.25-5.5%, awaiting stability in inflation measures to reach the central bank’s 2% target before implementing anticipated rate cuts.
Although banks are preparing for increased defaults later this year, Mulberry stated that defaults are not currently escalating at a pace indicative of a consumer crisis. He emphasized the importance of comparing homeowners and renters from the pandemic era. “While rates have risen significantly, homeowners locked in very low fixed rates, so they aren’t feeling the financial sting as much,” Mulberry explained. “Renters, on the other hand, were not afforded that opportunity.”
With rental prices surging more than 30% nationwide from 2019 to 2023 and grocery costs rising 25% during the same timeframe, renters who did not secure low rates are now facing the most significant financial strain.
Overall, the most notable takeaway from this earnings cycle is that “nothing new emerged this quarter regarding asset quality,” according to Narron. In fact, strong revenues, profits, and resilient net interest income all suggest a still-healthy banking sector.
“There’s resilience in the banking sector that may not have been entirely unexpected, but it is reassuring to see that the structures of the financial system remain robust and sound at this moment,” Mulberry said. “However, we are vigilant; the longer interest rates remain at these elevated levels, the more pressure they create.”