With interest rates at their highest in over 20 years and inflation continuing to strain consumers, major banks are preparing for increased risks linked 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 funds that banks allocate to cover potential losses from credit risks, which include bad debts and lending, particularly in commercial real estate.
JPMorgan set aside $3.05 billion for credit losses in the second quarter; Bank of America allocated $1.5 billion; Citigroup’s total allowance for credit losses reached $21.8 billion, more than tripling its reserve build from the previous quarter; and Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are bracing for a more challenging lending environment, where both secured and unsecured loans might result in larger losses. A recent analysis by the New York Fed revealed that Americans owe a cumulative $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, the rise in credit card issuance and delinquency rates reflects consumers relying more on credit as their pandemic savings diminish. Credit card balances reached $1.02 trillion in the first quarter of this year for the second consecutive quarter, exceeding the trillion-dollar mark, according to TransUnion. The commercial real estate sector remains particularly vulnerable.
“We’re still recovering from the COVID period, especially regarding banking and consumer health, largely due to the stimulus provided to consumers,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, concerns for banks are likely to materialize in the coming months. “The provisions you see at any given quarter don’t necessarily indicate credit quality for the last three months; they reflect what banks anticipate will occur in the future,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He noted a shift from a traditional approach, where rising loan defaults would lead to increased provisions, to one where macroeconomic forecasts primarily influence provisioning.
In the short term, banks expect slowing economic growth, rising unemployment, and potential interest rate cuts later in the year, which could lead to more delinquencies and defaults.
Citi’s chief financial officer Mark Mason pointed out that current warnings seem to be concentrated among lower-income consumers, whose savings have significantly decreased since the pandemic.
“While the overall U.S. consumer appears resilient, there are notable performance disparities across different income and credit score bands,” Mason said during a recent analyst call. He noted that only the highest income quartile has more savings than before 2019, and those with FICO scores above 740 are driving spending growth and maintaining high payment rates. Conversely, lower-income consumers are experiencing sharper declines in payment rates and are borrowing more, impacted by rising inflation and interest rates.
The Federal Reserve currently maintains interest rates at a 23-year high of 5.25% to 5.5%, awaiting stabilization in inflation measures towards its 2% target before making anticipated rate cuts.
Despite banks anticipating higher defaults later in the year, current figures do not suggest an impending consumer crisis, according to Mulberry. He highlighted a key distinction between homeowners and renters during the pandemic, noting that while interest rates have risen dramatically, homeowners who locked in low fixed rates on their debt are less affected.
In contrast, renters, whose expenses have increased significantly—over 30% for rents and 25% for groceries between 2019 and 2023—are feeling more financial pressure, especially with wages not keeping pace with rising costs.
Overall, the latest earnings reports indicate that there were no new developments regarding asset quality this quarter. Strong revenues, profits, and resilient net interest income reflect a still-healthy banking sector. Mulberry remarked, “There’s a strength in the banking sector that may not have been entirely expected, but it’s reassuring to assert that the financial system’s structures remain strong and sound at this moment.” However, he cautioned that prolonged high interest rates could lead to increased stress.