Amid rising interest rates, which are at their highest levels in over two decades, and persistent 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 from credit risks, including bad debt and loans, particularly in the commercial real estate sector.
JPMorgan allocated $3.05 billion for credit losses, Bank of America set aside $1.5 billion, Citigroup’s allowance reached $21.8 billion—more than tripling its reserve compared to the prior quarter—and Wells Fargo reported provisions of $1.24 billion.
The heightened provisions suggest that banks are preparing for a more precarious financial environment, where both secured and unsecured loans might lead to greater losses. A recent analysis by the New York Federal Reserve highlighted that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are on the rise, as many individuals exhaust their savings from the pandemic era and turn increasingly to credit. Total credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where balances surpassed the trillion-dollar mark, according to TransUnion. Commercial real estate also remains in a vulnerable position.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that we are still recovering from the COVID-19 pandemic, largely due to the prior stimulus provided to consumers.
Looking forward, banks are likely to encounter difficulties in the months ahead. Mark Narron, a senior director at Fitch Ratings, explained that quarterly provisions do not necessarily reflect past credit quality but rather banks’ expectations for the future.
Currently, banks predict a slowdown in economic growth, an increase in unemployment rates, and two interest rate cuts expected later this year, which could result in more delinquencies and defaults as the year wraps up.
Citi’s chief financial officer, Mark Mason, highlighted that the concerns are particularly evident among lower-income consumers, who have experienced significant declines in savings since the pandemic began.
Despite the resilience of the overall U.S. consumer, Mason pointed out a divergence in financial behavior based on income levels and credit scores. The highest income quartile has more savings than before 2019, while those in lower credit score bands are facing challenges, leading to increased borrowing and declining payment rates amid rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, holding off on cuts until inflation stabilizes towards the target of 2%.
Even as banks prepare for an uptick in defaults later this year, current default rates do not indicate a consumer crisis, according to Mulberry. He emphasized the contrast between homeowners and renters during this economic shift. Homeowners locked in low fixed rates during the pandemic and are less affected by rising rates, while renters now face increased costs without the benefit of low-rate mortgages.
Between 2019 and 2023, rents surged over 30% and grocery prices increased by 25%, particularly stressing renters who have not enjoyed fixed lower rates compared to homeowners.
Despite the looming challenges, Narron noted that the latest earnings reports did not reveal significant issues regarding asset quality. The banking sector continues to show strong revenues and resilient net interest income, suggesting a generally healthy financial landscape at this time.
Mulberry added that, while the banking sector remains robust, ongoing high interest rates could increase pressures in the long run.