As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are preparing for potential risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions are funds set aside to cover potential losses from credit risks, including overdue debts and commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion toward credit loss provisions in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s allowance reached $21.8 billion, significantly up from the previous quarter; and Wells Fargo provisioned $1.24 billion.
These increases indicate that banks are bracing for a challenging environment, where both secured and unsecured loans could lead to larger losses. A recent report from the New York Fed revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Rising credit card issuance and delinquency rates are also evident as consumers exhaust their pandemic savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where the total exceeded one trillion dollars, according to TransUnion. Additionally, the state of CRE continues to be uncertain.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector is still recovering from the COVID-19 pandemic, largely due to the stimulus provided to consumers.
However, challenges for banks are anticipated in the future.
Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, explained that the provisions reported in each quarter reflect banks’ expectations about future credit quality rather than past performance.
n the short term, banks predict a slowdown in economic growth, an increase in unemployment rates, and two interest rate cuts later this year, possibly in September and December. This projection could lead to more delinquencies and defaults as the year ends.
Citi’s chief financial officer, Mark Mason, highlighted that concerns are particularly evident among lower-income consumers who have seen a decline in their savings since the pandemic began.
“While the overall U.S. consumer remains resilient, we see varied performance across different income levels,” Mason stated during a conference call with analysts. “Only the highest income quartile has maintained higher savings since early 2019, with customers boasting scores above 740 driving spending growth and high payment rates. Conversely, those with lower scores are experiencing significant drops in payment rates and are taking on more debt due to the impacts of high inflation and interest rates.”
The Federal Reserve has maintained interest rates at a range of 5.25-5.5%, their highest in 23 years, awaiting stabilization in inflation towards the central bank’s 2% target before implementing widely anticipated rate cuts.
Despite mounting concerns, defaults have not yet surged to the level that indicates a consumer crisis. Mulberry is observing the discrepancy between homeowners and renters during this period. Homeowners, who secured low fixed-rate loans, are less affected by rising rates compared to renters facing escalating costs.
With rent increasing over 30% nationally from 2019 to 2023 and grocery prices climbing 25%, renters lacking low-rate opportunities are experiencing significant budgetary stress.
Nonetheless, analysts noted that the most recent earnings reports indicated stability in asset quality. Strong revenues, profits, and resilient net interest income signal a still-healthy banking sector.
“There remains some strength in the banking sector that may not have been entirely expected; however, it is reassuring to observe that the financial system’s structure remains robust at this time,” Mulberry stated. “That said, we are monitoring the situation closely, as prolonged high interest rates could lead to increased stress.”