With interest rates reaching their highest point in over two decades and inflation continuing to challenge consumers, major banks are bracing for increased risks linked to their lending practices.
In the second quarter of this year, 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 banks to cover potential losses from credit risks, which can include delinquent accounts and bad debt, particularly in sectors such as commercial real estate.
Specifically, JPMorgan earmarked $3.05 billion for credit loss provisions; Bank of America set aside $1.5 billion; Citigroup’s provisions amounted to a notable $21.8 billion—more than tripling its builds from the preceding quarter; and Wells Fargo’s provision was $1.24 billion.
These increased reserves indicate that banks are preparing for a more precarious lending environment, where both secured and unsecured loans might lead to greater losses. The New York Fed recently reported that Americans owe a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, credit card issuance is rising, alongside delinquency rates, as individuals tap into credit due to dwindling pandemic-era savings. According to TransUnion, credit card balances surpassed $1 trillion in the first quarter, marking the second consecutive quarter where the total exceeded this threshold. The commercial real estate sector also remains vulnerable.
“We’re still emerging from the COVID period, with banking and consumer health largely influenced by the stimulus given to consumers,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Challenges for banks are anticipated in the months to come. Mark Narron, a senior director at Fitch Ratings, pointed out that the provisions banks report in any given quarter do not solely reflect recent credit quality but rather expectations about future developments.
He explained, “Historically, provisions increased when loans began to default; now, macroeconomic forecasts significantly impact provisioning strategies.”
Looking ahead, banks expect economic growth to slow, unemployment rates to rise, and anticipate two interest rate cuts later this year. These factors could lead to more delinquencies and defaults as the year closes.
Citigroup’s CFO Mark Mason highlighted that concerns are particularly pronounced among lower-income consumers, who have seen their savings diminish post-pandemic. “Despite a generally resilient U.S. consumer, we notice significant variations in performance across different demographics,” he said. “Only the highest income quartile has more savings than before 2019, and customers with high FICO scores are leading spending growth and repayment rates. In contrast, those with lower FICO scores are experiencing a decline in payment rates and increased borrowing.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25%-5.5%, awaiting stabilization in inflation toward the central bank’s target of 2% before implementing the anticipated rate cuts.
Although banks are preparing for potential defaults in the latter part of the year, current default rates do not indicate an impending consumer crisis, Mulberry noted. He emphasizes the distinction between property owners and renters during the pandemic, as those who owned homes benefited from low fixed rates, while renters faced increasing financial pressure.
“Rent prices have surged over 30% across the country from 2019 to 2023, and grocery costs increased by 25% during this time. Renters who did not secure low rates are feeling the strain,” Mulberry explained.
For now, the earnings reports suggest no notable changes in asset quality, according to Narron. The banking sector has demonstrated strong revenues and profits, reflecting a still-robust financial system.
“There’s notable strength in the banking sector, which is reassuring, but we remain vigilant, as prolonged high-interest rates could induce further stress,” Mulberry added.