With interest rates at their highest in over 20 years and inflation continuing to pressure consumers, major banks are preparing for increased risks associated with their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all heightened their provisions for credit losses compared to the previous quarter. These provisions represent funds set aside by financial institutions to cover potential losses from credit risks, which includes bad debts and delinquencies, particularly in commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion in provisions for credit losses, Bank of America set aside $1.5 billion, Citigroup’s allowance reached a total of $21.8 billion—marking more than a threefold increase from the prior quarter—and Wells Fargo put aside $1.24 billion.
These elevated provisions indicate that banks are preparing for a riskier lending environment where both secured and unsecured loans may lead to larger losses. A recent analysis by the New York Fed revealed that American households carry a collective debt of $17.7 trillion made up of consumer loans, student loans, and mortgages.
Credit card issuance is on the rise, along with delinquency rates, as many people exhaust their pandemic-related savings and increasingly rely on credit. Credit card balances surpassed $1 trillion for the second consecutive quarter, totaling $1.02 trillion in the first quarter of this year, according to TransUnion. Additionally, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked on the ongoing transition from the COVID era, noting how consumer health was initially supported by government stimulus.
Challenges for banks are anticipated in the coming months. According to Mark Narron, a senior director at Fitch Ratings, the provisions banks report reflect their expectations for future credit quality rather than solely the recent past.
Narron indicated that banks foresee slowing economic growth, an uptick in unemployment, and two interest rate cuts expected later this year in September and December. This outlook could potentially lead to an increase in delinquencies and defaults as the year concludes.
Citi’s Chief Financial Officer Mark Mason pointed out that the warning signs of financial strain seem to be most pronounced among lower-income consumers, who have seen their savings diminish since the pandemic.
He observed that while the overall U.S. consumer sentiment remains resilient, there is a noticeable disparity in financial stability across different income levels. Only the wealthiest quartile of clients has maintained higher savings compared to the beginning of 2019. Those with higher credit scores are contributing to growth in spending and maintaining solid payment rates, while those with lower credit scores are facing greater challenges, including declining payment rates and increased borrowing driven by inflation and rising interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%. The central bank is awaiting stabilization in inflation rates toward its 2% target before executing anticipated rate cuts.
Despite banks bracing for potential defaults in the latter half of the year, current trends do not indicate a consumer crisis yet, according to Mulberry. He is particularly monitoring the differences between homeowners and renters, noting that while interest rates have risen significantly, many homeowners benefited from locking in lower fixed rates during the pandemic.
In contrast, renters, who faced rising rents—over 30% nationwide from 2019 to 2023—and grocery costs up 25% during the same period, are experiencing greater pressure on their budgets.
Overall, the latest earnings reports from banks show no alarming changes in asset quality. The sector remains robust with strong revenues, profits, and healthy net interest income.
Mulberry concluded that while the banking system shows resilience and strength, ongoing high interest rates could lead to more stress down the line.