As interest rates reach heights not seen in over two decades and inflation continues to impact 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 all increased their provisions for credit losses compared to the previous quarter. These provisions represent funds that banks reserve to cover potential losses from credit-related risks, including bad debt and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s total allowance for credit losses reached $21.8 billion by the end of the quarter, more than tripling its reserves from the prior period; and Wells Fargo accounted for $1.24 billion in provisions.
This increase in reserves indicates that banks are preparing for a riskier lending environment, which could lead to greater losses from both secured and unsecured loans. The New York Fed recently reported that American households are collectively burdened with $17.7 trillion in consumer, student, and mortgage loans.
Additionally, credit card issuance and delinquency rates are on the rise as consumers exhaust their pandemic-era savings and increasingly depend on credit. Credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. The commercial real estate sector also remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, emphasized the ongoing impacts of the COVID era and the importance of the consumer stimulus that was injected during that time.
However, any potential issues for banks could become more evident in the coming months. Mark Narron, a senior director with Fitch Ratings, explained that quarterly provisions may not directly reflect recent credit quality but instead indicate banks’ expectations for the future.
In the near future, banks anticipate slowing economic growth, a rising unemployment rate, and potential interest rate cuts in September and December, which could lead to more delinquencies and defaults by year-end.
Citi’s Chief Financial Officer Mark Mason observed that challenges appear particularly pronounced among lower-income consumers, who have seen a decline in savings since the pandemic. He noted a discrepancy in financial health, stating that only the highest income quartile has managed to increase their savings since early 2019.
While the overall U.S. consumer remains resilient, there are distinctions based on credit scores and income levels. Mason pointed out that consumers with higher credit scores are contributing to spending growth and maintaining good payment rates, whereas those with lower credit scores are experiencing significant drops in payment rates and are increasingly reliant on borrowing due to rising inflation and interest rates.
The Federal Reserve currently maintains interest rates at a 23-year high of 5.25-5.5% as it monitors inflation levels toward its 2% target prior to any anticipated rate reductions.
Despite banks’ preparations for a potential uptick in defaults, current data do not yet suggest a consumer crisis, according to Mulberry. He highlighted the difference between homeowners and renters during the pandemic. Homeowners secured low fixed-rate mortgages, insulating them from immediate financial strain, while renters have faced escalating rents and costs of living.
Since 2019, rents have surged more than 30% nationally, and grocery prices have increased by 25%, putting additional pressure on renters who lack the security of locked-in low rates.
For now, banks’ latest earnings reports indicate stability in asset quality, with strong revenues, profits, and healthy net interest income suggesting a robust banking sector. Mulberry expressed cautious optimism, acknowledging the financial system’s current strength but noting that prolonged high interest rates could induce more stress in the future.