As interest rates reach their highest levels in over twenty years and inflation continues to impact consumers, major banking institutions are preparing for increased risks associated with their lending practices.
During the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions represent funds that banks set aside to cover potential losses from credit risks, including defaults and non-performing loans such as those in the commercial real estate sector.
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s total allowance reached $21.8 billion, more than tripling its previous quarter’s reserve; and Wells Fargo’s provisions were $1.24 billion.
These increases indicate that banks are preparing for a challenging economic landscape, where the risks associated with both secured and unsecured loans could lead to greater losses. A recent analysis by the Federal Reserve Bank of New York revealed that American households owe approximately $17.7 trillion in consumer debt, student loans, and mortgages.
Credit card usage, along with rising delinquency rates, are evident as consumers deplete their pandemic savings and increasingly rely on credit. TransUnion reported that credit card balances topped $1.02 trillion in the first quarter of this year, marking the second consecutive quarter of balances exceeding the trillion-dollar threshold. Additionally, the commercial real estate sector remains vulnerable.
Brian Mulberry, a portfolio manager at Zacks Investment Management, commented on the current economic recovery from the COVID-19 pandemic and emphasized the stimulus measures that have supported consumer spending.
Problems for banks may manifest in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions do not solely reflect past credit quality but also indicate banks’ expectations for future conditions.
He noted a shift in how provisions are determined, driven more by macroeconomic forecasts than by actual loan performance. Banks anticipate slower economic growth, higher unemployment, and potential interest rate cuts in September and December, which could lead to more delinquencies and defaults by year-end.
Citigroup’s CFO Mark Mason pointed out that indicators of distress are particularly evident among lower-income consumers who have seen their savings decline since the pandemic began.
While consumer spending remains relatively robust, Mason observed a divergence based on income and credit scores. Only the highest income quartile has increased savings since 2019, while lower-income individuals with lower credit scores are experiencing significant decreases in payment rates and increased borrowing due to high inflation and interest costs.
The Federal Reserve is maintaining interest rates at a 23-year high range of 5.25% to 5.5%, awaiting inflation metrics to stabilize toward a target of 2% before proceeding with expected rate cuts.
Despite banks bracing for a rise in defaults, current trends do not suggest an imminent consumer crisis, according to Mulberry. He noted the distinction between homeowners and renters, with many homeowners having secured low fixed-rate mortgages during the pandemic, shielding them from immediate financial stress.
In contrast, renters, who have faced rental prices rising over 30% from 2019 to 2023 and grocery costs escalating by 25%, are under significant budgetary strain due to wage growth lagging behind these increases.
For now, analysts have observed no significant new developments concerning asset quality in the latest earnings reports. Strong revenues, profitability, and a healthy net interest income signal a resilient banking sector. However, Mulberry cautioned that persistent high interest rates may continue to exert pressure on financial stability.