As interest rates reach heights not seen in over two decades and inflation continues to pressure consumers, major banks are bracing for potential risks associated with 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 are funds set aside by financial institutions to address possible losses from credit risk, including delinquent debts and commercial real estate loans.
JPMorgan allocated $3.05 billion for its credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s provision grew to $21.8 billion, significantly higher than the previous quarter; and Wells Fargo reported $1.24 billion in provisions.
These increased provisions indicate that banks anticipate a riskier lending environment, with both secured and unsecured loans potentially leading to more significant losses. Recent data from the New York Federal Reserve revealed that U.S. households collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are rising as people deplete their pandemic savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of the year, marking the second consecutive quarter of balances exceeding the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also faces ongoing instability.
“We’re still recovering from the COVID era, particularly regarding banking and consumer health, largely due to the stimulus provided,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Challenges for banks may become more pronounced in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that the quarterly provisions reflect banks’ future expectations rather than past credit quality.
“Historically, provision levels would increase only after loans began to default; now, macroeconomic forecasts substantially influence provisioning,” Narron explained.
In the short-term, banks foresee slowing economic growth, a rising unemployment rate, and two anticipated interest rate cuts later this year. This outlook suggests that delinquencies and defaults could escalate as the year progresses.
Citigroup CFO Mark Mason observed that concerns are particularly focused on lower-income consumers who have seen their savings decline since the pandemic began.
“While the overall U.S. consumer appears resilient, there’s a noticeable divergence in performance between different income groups and credit scores,” Mason noted. He pointed out that only the wealthiest quartile has managed to save more than they did in early 2019, with those possessing higher credit scores driving growth in spending and maintaining their payment rates. In contrast, customers with lower credit scores are facing significant challenges and relying more on borrowing as they are hit harder by rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year peak of 5.25-5.5% as it awaits stabilization of inflation measures towards its 2% target before implementing anticipated rate cuts.
Despite current preparations for increased defaults, Mulberry indicated that defaults are not yet rising at a level that signals an impending consumer crisis. He is particularly monitoring the differences between homeowners who locked in low fixed rates during the pandemic and renters who did not have that opportunity.
While homeowners have largely avoided financial strain, renters have been squeezed as rent prices soared over 30% nationwide between 2019 and 2023, and grocery prices increased by 25% during the same timeframe. This has left renters, who have not benefited from lower rates, under significant financial pressure.
However, the most recent earnings reports reveal that asset quality remains stable, according to Narron. He noted strong revenues, profits, and net interest income as positive indicators for the banking sector’s health.
“There is a resilience in the banking sector that may not have been fully anticipated, but it is reassuring to acknowledge that the foundations of the financial system are still sound at this time,” Mulberry concluded. “That said, we are closely monitoring the situation, as prolonged high interest rates will inevitably increase stress on the system.”