As interest rates reach their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for increased risks related to 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 are reserves set aside by financial institutions to cover potential losses from credit risks, including bad debt and loans, such as those in commercial real estate.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s allowance for credit losses reached $21.8 billion, which is more than three times its build from the previous quarter; and Wells Fargo maintained $1.24 billion in provisions.
These increased reserves indicate that banks are preparing for a more challenging financial environment, where both secured and unsecured loans may lead to greater losses. A report by the New York Federal Reserve revealed that American households collectively hold $17.7 trillion in consumer, student, and mortgage debt.
Additionally, credit card issuance is rising, alongside increasing delinquency rates, as consumers exhaust their pandemic-era savings and turn to credit. In the first quarter, total credit card balances hit $1.02 trillion, marking the second consecutive quarter that exceeded the trillion-dollar mark, according to TransUnion. The commercial real estate sector also remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted, “We’re still emerging from the COVID era, and the health of the consumer largely depended on the stimulus that was provided.”
However, banks are anticipating that challenges may arise in the coming months. Mark Narron, a senior director at Fitch Ratings, emphasized that current provisions do not necessarily reflect recent credit quality but rather banks’ expectations of future performance.
He noted, “Historically, when loans began to default, provisions would increase. Now, macroeconomic forecasts primarily drive provisioning.”
In the short term, banks foresee slow economic growth, rising unemployment rates, and two interest rate cuts anticipated between September and December. Such conditions could lead to more delinquencies and defaults as the year concludes.
Citi’s Chief Financial Officer Mark Mason highlighted that potential difficulties appear concentrated among lower-income consumers, many of whom have seen their savings diminish since the pandemic.
“While the overall U.S. consumer remains resilient, we see a divergence in performance across income levels,” Mason explained in a recent analyst call. He added that only the highest-income households have maintained more savings than they had at the start of 2019, and it is primarily those with higher credit scores driving spending growth and maintaining payment rates. In contrast, customers with lower credit scores are experiencing sharper declines in payment rates and increasing borrowing, impacted more severely by inflation and high-interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation measures toward its 2% target before implementing anticipated rate cuts.
Despite banks preparing for increased defaults in the latter half of the year, Mulberry noted that current default rates do not yet indicate a consumer crisis. He is monitoring differences between homeowners and renters from the pandemic period.
While interest rates have risen significantly, he explained, homeowners benefited from locking in low fixed rates, allowing them to avoid financial strain. Conversely, those who were renting during that time missed out on that opportunity.
With rents increasing by over 30% nationwide from 2019 to 2023 and grocery costs rising by 25%, renters who could not secure low rates are facing more pressure on their budgets.
Overall, this quarter’s earnings report did not present any new concerns regarding asset quality, according to Narron. Strong revenue, profits, and resilient net interest income remain positive signs for the banking sector’s health.
Mulberry concluded, “While the banking sector shows strength, we must remain vigilant, as prolonged high-interest rates will increase financial stress.”