With interest rates reaching over two-decade highs and inflation impacting 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 serve as a financial cushion for potential losses from credit risks, including bad debts and commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses, while Bank of America allocated $1.5 billion. Citigroup increased its credit loss allowance to $21.8 billion by the end of the quarter, marking a substantial rise from the previous period. Wells Fargo’s provisions amounted to $1.24 billion.
These heightened provisions signal that banks are preparing for a riskier environment, as both secured and unsecured loans may lead to significant losses. A recent analysis by the New York Fed highlighted that American households collectively owe $17.7 trillion across various debt forms, including consumer loans, student loans, and mortgages.
As pandemic-era savings diminish, credit card use is increasing, along with delinquency rates. In the first quarter of this year, credit card balances reached $1.02 trillion, making it the second consecutive quarter where the total surpassed the trillion mark, as reported by TransUnion. The commercial real estate sector is also facing challenges.
Experts suggest the banking sector is still recovering from the COVID-19 pandemic, with stimulus measures having previously bolstered consumer health. However, any emerging issues for banks are expected to manifest in the coming months.
The provisions reported do not always reflect recent credit quality but are influenced by banks’ expectations about future conditions, according to Mark Narron from Fitch Ratings. He noted that the industry has transitioned from a reactive to a pro-active approach regarding credit quality, with macroeconomic factors driving provisioning decisions.
Banks are currently forecasting slower economic growth and a potential rise in the unemployment rate, along with two anticipated interest rate cuts in September and December. This scenario suggests a likelihood of increased delinquencies and defaults by the year’s end.
Citi’s CFO Mark Mason highlighted that concerns are particularly evident among lower-income consumers whose savings have deteriorated post-pandemic. He indicated that while the overall U.S. consumer remains resilient, performance diverges significantly across different income and credit segments.
Currently, only the highest income quartile maintains greater savings than in 2019. Conversely, consumers with lower credit scores are experiencing diminished payment rates and are increasingly reliant on credit due to inflationary pressures.
As the Federal Reserve holds interest rates at a high of 5.25-5.5% in anticipation of inflation stabilizing towards its 2% target, banks are preparing for potential defaults in the latter half of the year. However, Mulberry mentioned that defaults are not yet escalating to crisis levels. He emphasized the disparity between homeowners, who secured low fixed rates during the pandemic, and renters, who face rising costs and financial strain.
From 2019 to 2023, rents surged by over 30%, while grocery prices increased by 25%, imposing significant stress on renters’ budgets, as noted by Mulberry.
Despite concerns, the latest earnings report indicates stability within the banking sector, with no alarming trends in asset quality. Strong revenues, profits, and healthy net interest income demonstrate the ongoing robustness of the financial system. Industry observers remain cautious, acknowledging that sustained high interest rates could introduce further stress over time.