As interest rates remain at their highest level in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks associated with their lending activities.
In the second quarter, leading financial institutions including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo heightened their provisions for credit losses compared to the previous quarter. These provisions represent the funds that banks set aside to mitigate potential losses linked to credit risks, which can include delinquent debts and commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit losses during the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, significantly increasing its reserves from the previous quarter. Wells Fargo’s provisions totaled $1.24 billion.
These increased provisions signal that banks are preparing for a more challenging environment, where both secured and unsecured loans may lead to larger losses. According to a recent report from the New York Federal Reserve, Americans currently owe approximately $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card issuance is on the rise, along with delinquency rates, as individuals deplete their pandemic-era savings and increasingly rely on credit. In the first quarter of this year, credit card balances surpassed $1 trillion for the second consecutive quarter, as reported by TransUnion. The commercial real estate sector also remains vulnerable.
Experts like Brian Mulberry from Zacks Investment Management note that the banking landscape is still recovering from the COVID-19 pandemic, driven largely by government stimulus measures aimed at consumers.
However, challenges for banks are anticipated in the coming months. Mark Narron from Fitch Ratings emphasizes that current provisions reflect banks’ expectations for the future rather than credit quality from the past three months. This indicates a shift in provisioning practices, moving away from reactions to bad loans toward a reliance on macroeconomic forecasts.
Looking ahead, banks predict a slowdown in economic growth, an uptick in unemployment rates, and potential interest rate cuts later this year in September and December, which could lead to higher delinquency and default rates.
Citi’s CFO Mark Mason highlighted that warning signs appear concentrated among lower-income consumers, whose savings have diminished since the pandemic. He pointed out that while overall consumer behavior appears resilient, only the highest income quartile has maintained more savings than before 2019. Conversely, lower-income consumers are facing greater financial strain due to rising inflation and interest rates, with declines in payment rates observed among those with lower credit scores.
The Federal Reserve has kept interest rates at a range of 5.25% to 5.5%, the highest in 23 years, as it awaits stable inflation measurements to reach its target of 2% before implementing anticipated rate cuts.
Despite banks preparing for possible increased defaults later in the year, analysts like Mulberry indicate that defaults are not yet rising sharply enough to signify a consumer crisis. He observes a distinct divide between homeowners who secured low fixed mortgage rates during the pandemic and renters who have faced surging rental prices.
Rental costs have risen more than 30% from 2019 to 2023, while grocery prices have increased by 25% in the same period, putting renters under significant financial pressure compared to those who locked in lower rates on their mortgages.
Currently, the key takeaway from the latest earnings reports is that there are no new concerns regarding asset quality, with strong revenues, profits, and net interest income indicating a still-resilient banking sector. According to Mulberry, there remains a solid foundation within the financial system, although prolonged high interest rates could introduce more stress in the future.