As interest rates remain at their highest level in over 20 years and inflation continues to affect consumers, major banks are bracing for potential risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo each increased their provisions for credit losses from the previous quarter. These provisions reflect the funds that financial institutions set aside to mitigate potential losses resulting from credit risk, including unpaid debts and various loans such as commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter; Bank of America added $1.5 billion; Citigroup’s total allowance reached $21.8 billion—a figure that more than tripled from the previous quarter; and Wells Fargo allocated $1.24 billion toward these provisions.
These increases indicate that banks are preparing for a more unpredictable economic landscape, where both secured and unsecured loans could lead to greater losses. According to a recent analysis conducted by the New York Federal Reserve, American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, the issuance of credit cards, as well as delinquency rates, are on the rise as individuals exhaust their pandemic-era savings and increasingly rely on credit. For the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter where the total exceeded the trillion-dollar mark, based on data from TransUnion. Additionally, the CRE sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the ongoing effects of the COVID era, particularly concerning consumer health and banking. He noted that government stimulus played a significant role during this time.
Experts anticipate that any challenges for banks may arise in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that quarterly provisions do not solely reflect credit quality from the last three months but rather banks’ expectations for the future.
He emphasized that the current environment has shifted from a historical model, where provisions rose in response to rising loan defaults, to one driven by macroeconomic forecasts.
In the short term, banks predict slower economic growth, a rise in unemployment, and two anticipated interest rate cuts later this year. This outlook raises concerns about increasing delinquencies and defaults as the year progresses.
Citi’s Chief Financial Officer Mark Mason highlighted that warning signs are particularly evident among lower-income consumers, who have seen their savings diminish since the pandemic. He noted a divergence in consumer performance, with only the highest income quartile reporting more savings than pre-pandemic levels.
Mason indicated that while spending growth and high payment rates are occurring mainly among high-income earners and those with excellent credit scores, individuals with lower credit scores are facing challenges as inflation and rising interest rates impact their financial situations.
The Federal Reserve has maintained a 23-year high interest rate of 5.25-5.5% while awaiting inflation measures to stabilize towards its 2% target before implementing expected rate cuts.
Despite banks’ preparations for potential defaults in the latter half of the year, Mulberry pointed out that current default rates do not signal an impending consumer crisis. He noted the contrasting experiences of homeowners during the pandemic—who secured low fixed-rate mortgages—and renters, who are now facing increased rental costs.
Rents have surged over 30% nationwide from 2019 to 2023, while grocery prices have jumped 25% in the same timeframe, putting additional financial strain on renters who were unable to lock in lower rates.
Overall, during this earnings season, analysts observed no significant shifts in asset quality. Strong revenues, profits, and resilient net interest income are viewed as positive indicators for the ongoing health of the banking sector. Mulberry remarked on the stability within the financial system, though he cautioned that sustained high interest rates could lead to increased stress over time.