As interest rates reach their highest levels in over twenty years and inflation continues to impact consumers, major banks are preparing for greater risks related 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 that banks allocate to mitigate potential losses from credit risks such as overdue debts and troubled loans, including commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s credit loss allowance reached $21.8 billion by the end of the quarter, marking more than a threefold increase from the previous quarter’s reserve, and Wells Fargo reported provisions totaling $1.24 billion.
These increased provisions indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans may lead to larger losses. A recent examination of household debt by the New York Federal Reserve revealed that Americans collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
The issuance of credit cards, along with rising delinquency rates, is also becoming a concern as individuals deplete their pandemic-era savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, the second consecutive quarter with balances exceeding the trillion-dollar threshold, according to TransUnion. Moreover, the commercial real estate sector remains vulnerable.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the effects of the COVID era still linger, particularly regarding consumer financial health, largely influenced by distributed stimulus funds.
Problems for banks may emerge in the coming months, as Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained. He noted that the provisions recorded in any specific quarter are not necessarily indicative of recent credit quality, but rather are based on banks’ expectations for future conditions.
Narron added that the shift has moved from a historical approach where rising bad loans triggered increased provisions to one where macroeconomic forecasts primarily dictate provisioning measures.
Short-term forecasts from banks indicate expectations of slowing economic growth, a higher unemployment rate, and potential interest rate cuts later this year in September and December, which could lead to more delinquencies and defaults.
Citigroup’s chief financial officer, Mark Mason, highlighted that these warning signs are particularly evident among lower-income consumers, whose savings have shrunk since the pandemic. He remarked on the disparity in savings levels, noting that only the highest income quartile has managed to increase their savings since early 2019, while those with lower FICO scores have experienced declines in payment rates and are relying more on credit due to the pressures of inflation and rising interest rates.
The Federal Reserve is maintaining interest rates at a 23-year peak of 5.25-5.5%, waiting for inflation to move closer to its 2% target before considering the anticipated rate cuts.
Despite banks bracing for potential rising defaults, current data does not indicate a looming consumer crisis, according to Mulberry. He pointed out that while interest rates have surged, homeowners who locked in low fixed rates on their debts are not feeling the impact as acutely as renters who missed that opportunity.
Rent prices have risen over 30% nationwide from 2019 to 2023, and grocery costs have also surged by 25%, placing substantial pressure on renters who have not seen their wages keep pace.
For now, the recent earnings reports suggest stability within the banking sector, with Mark Narron commenting that “there was nothing new this quarter in terms of asset quality.” The banking sector continues to display strong revenues, profits, and robust net interest income.
Mulberry emphasized that while the financial system remains solid, the prolongation of high interest rates could introduce additional stress.