With interest rates at their highest level in over twenty years and inflation affecting consumers, major banks are bracing for potential risks linked to their lending activities.
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 the funds set aside by financial institutions to cover possible losses from credit risk, including bad debts and loans such as commercial real estate (CRE).
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, more than tripling from the previous quarter, and Wells Fargo provisioned $1.24 billion.
The increased reserves indicate that banks are preparing for a riskier lending environment, where both secured and unsecured loans could lead to greater losses. Recent research from the New York Federal Reserve highlights that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are climbing as consumers exhaust their pandemic-era savings and increasingly depend on credit. According to TransUnion, credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where the total surpassed one trillion dollars. The commercial real estate sector also remains uncertain.
“We’re still recovering from the COVID era, particularly in banking and consumer health, which was significantly influenced by the stimulus provided to consumers,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Challenges for banks are anticipated in the upcoming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, noted, “The provisions reported in any quarter do not solely reflect the past three months’ credit quality; they indicate banks’ expectations for the near future.”
He elaborated that the focus has shifted from a historical model, where loan performance primarily guided provisions, to one where macroeconomic forecasts heavily influence provisioning decisions.
Banks are forecasting slowed economic growth, an increase in unemployment rates, and potential interest rate cuts later this year. These conditions could lead to more delinquencies and defaults as the year progresses.
Citigroup’s chief financial officer, Mark Mason, highlighted that concerns are particularly evident among lower-income consumers, who have seen their savings diminish since the pandemic.
“Although the U.S. consumer overall remains resilient, we see disparities in performance across different income and credit score categories,” Mason explained in a recent analyst call. He pointed out that only the highest income quartile has maintained more savings than before the pandemic, while borrowers with lower credit scores are experiencing a decline in payment rates and increasing reliance on credit due to the impact of high inflation and interest rates.
The Federal Reserve has maintained interest rates at 5.25-5.5%, their highest in 23 years, as it monitors inflation’s movement toward the target rate of 2% before contemplating cuts.
Despite banks gearing up for more defaults later this year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He is observing the differences between homeowners and renters since the pandemic.
“Yes, interest rates have risen significantly, but homeowners secured low fixed rates on their debts, so they are not experiencing the same level of pressure,” Mulberry noted. “In contrast, renters missed that opportunity.”
With rental costs surging over 30% nationwide between 2019 and 2023, and grocery prices rising by 25% during the same period, renters who could not secure low rates face significant financial strain as rental prices outpace wage growth.
Currently, analysts suggest that “there’s nothing new this quarter in terms of asset quality.” Strong revenues, profits, and consistently healthy net interest income indicate a robust banking sector.
“There is a strength in the banking sector that may not have been fully anticipated, but it is reassuring to see that the financial system remains sound at this time,” Mulberry asserted. “However, we are keeping a close eye on developments, as prolonged high-interest rates may lead to additional stress.”