As interest rates reach their highest levels in over two decades and inflation continues to impact consumers, major banks are preparing 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 are set aside to cover potential losses from credit risk, including overdue payments, bad debts, and lending, particularly in areas such as commercial real estate (CRE) loans.
JPMorgan established $3.05 billion in provisions for credit losses; Bank of America set aside $1.5 billion; Citi’s allowance rose to $21.8 billion at the end of the quarter—more than tripling its previous reserve; and Wells Fargo reported $1.24 billion in provisions.
These increased reserves indicate that banks are preparing for a riskier lending environment, where both secured and unsecured loans may lead to greater losses. A recent analysis from the New York Federal Reserve revealed that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates have also risen, as many consumers exhaust their pandemic-era savings and turn to credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter where the total exceeded the trillion-dollar threshold, according to TransUnion. Commercial real estate also remains in a fragile state.
According to Brian Mulberry, a portfolio manager at Zacks Investment Management, the banking and consumer health landscape is still recovering from the COVID era and the related stimulus efforts.
However, any challenges for banks are anticipated to emerge in the months to come.
Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported in any given quarter do not necessarily reflect the credit quality from the preceding three months, but rather banks’ expectations for the future. He noted a shift from a framework where loan defaults drove provisions upward to one where macroeconomic forecasts drive financial strategies.
In the short term, banks expect slower economic growth, a rise in unemployment rates, and two potential interest rate cuts later this year in September and December, which could result in more delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, highlighted that concerning trends seem to be especially pronounced among lower-income consumers who have seen their savings diminish since the pandemic.
“While there is an overall resilient U.S. consumer, we also observe a divergence in performance across different income levels and credit scores,” Mason noted in a recent analysts’ call. He pointed out that only the highest-income quartile has more savings than in early 2019, with consumers having credit scores above 740 contributing to spending growth. In contrast, lower-scoring consumers are experiencing declining payment rates and borrowing more as they struggle with high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation measures towards the central bank’s 2% target before implementing expected rate cuts.
Despite preparing for increased defaults later this year, experts caution that such defaults have not yet increased to levels indicative of a consumer crisis. Mulberry emphasized the contrast between homeowners, who locked in low fixed rates during the pandemic, and renters who lack that opportunity.
While homeowners continue to benefit from low fixed rates, renters face significant challenges, with national rents rising over 30% from 2019 to 2023 and grocery costs increasing by 25% during the same period. Many renters haven’t experienced wage growth that matches these rising living costs.
Overall, Key conclusions from the latest earnings show no new issues concerning asset quality, according to Narron. Strong revenue, profits, and robust net interest income are seen as positive signs for the banking sector’s health.
“There is some resilience in the banking sector that may not have been entirely expected, but it is reassuring to see that the foundations of the financial system remain strong and stable,” Mulberry remarked. However, he cautioned that continued high interest rates could lead to more strain in the future.