As interest rates reach their highest levels in over 20 years, and inflation continues to impact consumers, major banks are bracing for potential risks in 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 financial reserves set aside to counter potential losses from credit risks, including delinquent debts and problematic lending, such as loans for commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit loss provisions in the second quarter, while Bank of America earmarked $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, more than tripling its reserves from the prior period, and Wells Fargo allocated $1.24 billion for similar purposes.
These increased reserves indicate that banks are preparing for a more challenging financial landscape, where both secured and unsecured loans could lead to larger losses. A recent study by the New York Fed revealed that U.S. households owe a combined total of $17.7 trillion in consumer, student, and mortgage loans.
Rising credit card issuance and delinquency rates are also notable, as individuals deplete their pandemic savings and increasingly rely on credit. Total credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter that balances exceeded the trillion-dollar threshold, according to TransUnion. The commercial real estate sector remains particularly vulnerable as well.
“We’re still emerging from the COVID period, and much of that relates to the stimulus efforts aimed at consumers,” said Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, bank challenges may arise in the coming months.
“The provisions reported in any given quarter don’t necessarily reflect the credit quality from the last three months; they represent banks’ future expectations,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He continued, “It’s interesting because we’ve shifted from a system where rising loan defaults increased provisions to one where macroeconomic forecasts primarily influence these reserves.”
In the short term, banks forecast slowing economic growth, a rise in unemployment, and two anticipated interest rate cuts in September and December, according to Narron. This could lead to increased delinquencies and defaults as the year concludes.
Citi’s Chief Financial Officer Mark Mason remarked that these warning signs appear to be concentrated among lower-income consumers, who have witnessed a decline in savings since the pandemic began.
“While the overall U.S. consumer remains resilient, we see distinct differences in performance and behavior across various income levels,” Mason noted during an analyst call this month.
“Among our consumer clientele, only the highest income quartile has maintained or increased savings compared to 2019, with higher FICO score customers driving spending growth and sustaining high payment rates. Conversely, those in lower FICO brackets are experiencing steeper declines in payment rates and increasing borrowings due to the pressures from high inflation and interest rates,” he added.
The Federal Reserve has kept interest rates at 5.25-5.5%, a 23-year high, as it seeks stabilization in inflation metrics toward its 2% target before implementing the anticipated rate cuts.
Despite banks preparing for wider defaults later in the year, current default rates do not indicate a consumer crisis yet, according to Mulberry. He observes a distinction between homeowners and renters from the pandemic period.
“Yes, rates have increased significantly since then, but homeowners secured very low fixed rates on their debt, so they aren’t feeling the pain as much,” Mulberry explained. “In contrast, renters did not have that opportunity.”
With rents soaring over 30% nationwide from 2019 to 2023 and grocery prices climbing 25% in the same timeframe, renters who didn’t lock in low rates are under the most financial stress as their budgets tighten against rising living costs.
Ultimately, the recent earnings reports suggest no significant negative trends in asset quality. Strong revenues, profits, and stable net interest income are encouraging signs for the banking sector.
“There’s resilience in the banking sector that may be somewhat unexpected, but it’s reassuring to see that the foundation of the financial system remains robust at this time,” Mulberry concluded. “However, we will be monitoring the situation closely, as prolonged high interest rates can induce more stress.”