As interest rates reach over two-decade highs and inflation continues to impact consumers, major banks are bracing for potential challenges stemming from their lending activities.
In the second quarter, leading banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions, which are reserved to cover possible losses from credit risk—including delinquent debt and lending practices related to commercial real estate—reflect growing concerns about the lending environment.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses surged to $21.8 billion by the quarter’s end, more than tripling its previous reserve, and Wells Fargo recorded provisions of $1.24 billion.
These significant reserves indicate that banks are preparing for a riskier economic landscape, where both secured and unsecured loans may result in larger losses. A recent analysis from the New York Fed revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as many individuals deplete their pandemic-era savings and increasingly turn to credit. During the first quarter, credit card balances reached $1.02 trillion, marking the second consecutive quarter that total cardholder balances surpassed the trillion-dollar mark. Additionally, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the ongoing impact of the COVID era, emphasizing that stimulus measures played a crucial role in supporting consumer health.
Experts suggest that potential issues for banks may emerge in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that the current provisions reflect banks’ future expectations rather than recent credit quality. He noted a shift from a traditional model, where rising defaults led to increased provisions, to one driven by macroeconomic forecasts.
Short-term projections indicate slowing economic growth, rising unemployment, and anticipated interest rate cuts later this year, which could lead to increased delinquencies and defaults.
Citi’s chief financial officer, Mark Mason, highlighted concerns about lower-income consumers, whose savings have significantly diminished since the pandemic. He pointed out a disparity in financial health among consumers, noting that only the highest-income quartile has managed to retain more savings than in early 2019. Meanwhile, customers with lower credit scores are experiencing greater financial strain.
The Federal Reserve’s decision to maintain interest rates at a 23-year high of 5.25-5.5% is tied to efforts to stabilize inflation towards its 2% target before implementing expected rate cuts.
Despite banks preparing for a potential rise in defaults later this year, Mulberry indicated that current default rates do not signal a consumer crisis. He is particularly attentive to the differences between homeowners and renters during the pandemic, emphasizing that homeowners, who locked in low fixed rates, may not feel the financial pressure as acutely as renters facing rising costs.
With rents increasing by over 30% nationally from 2019 to 2023 and grocery prices climbing by 25%, renters are struggling with budget constraints, while homeowners enjoy the benefits of their lower fixed-rate mortgages.
Ultimately, the latest earnings reports suggest continuity in asset quality, with strong revenues, profits, and resilient net interest income pointing to a robust banking sector. Mulberry described the stability of financial structures as a positive sign but cautioned that prolonged high-interest rates could lead to increasing stress in the future.