As interest rates soar to their highest levels in over two decades and inflation continues to challenge consumers, major banks are preparing for increased risks associated with their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all augmented their provisions for credit losses compared to the previous quarter. These provisions represent funds that financial institutions allocate to cover potential losses from credit risk, including delinquent debts and loans, such as commercial real estate (CRE) loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America reserved $1.5 billion. Citigroup’s allowance for credit losses totaled $21.8 billion at the quarter’s end, marking more than a threefold increase from the previous quarter. Wells Fargo recorded provisions of $1.24 billion.
The increase in provisions indicates that banks are bracing for a riskier economic environment, where losses from both secured and unsecured loans could escalate for some of the largest financial institutions in the country. A recent New York Fed analysis revealed that American households collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as individuals deplete their pandemic-era savings and increasingly rely on credit. According to TransUnion, total credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total balances exceeded the trillion-dollar threshold. Meanwhile, the commercial real estate sector remains vulnerable.
“We’re still emerging from the COVID era, particularly regarding banking and consumer health, which heavily relied on the stimulus deployed to consumers,” explained Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Experts caution that any challenges faced by banks may materialize in the coming months. “Provisions reported in any given quarter do not necessarily reflect credit quality over the last three months; instead, they indicate what banks anticipate for the future,” noted Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
He added, “Historically, when loans began to default, provisions would increase. Now, macroeconomic forecasts predominantly drive provisioning.”
In the short term, banks foresee slow economic growth, a rise in unemployment, and two anticipated interest rate cuts later in the year, which could lead to heightened delinquencies and defaults by year-end.
Citi’s chief financial officer Mark Mason highlighted that warning signs are particularly prevalent among lower-income consumers, who have seen their savings diminish since the pandemic began. “While we still see an overall resilient U.S. consumer, disparities in performance and behavior are emerging across different income levels,” Mason remarked in a recent call with analysts.
He pointed out that only the wealthiest consumers have more savings than before 2019, while those with credit scores below 740 are experiencing notable declines in payment rates and increased borrowing due to high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting more stable inflation measures to reach its 2% target before implementing sought-after rate cuts.
Despite banks preparing for potential defaults later this year, current default rates do not signal an impending consumer crisis, according to Mulberry. He highlighted a notable distinction between homeowners and renters during the pandemic. “Homeowners locked in low fixed rates on their debt, and thus are largely insulated from the current financial strain,” he said. “Renters, on the other hand, have not had that advantage.”
With rents climbing over 30% nationally and grocery prices increasing by 25% from 2019 to 2023, renters—especially those not benefiting from prior low rates—are feeling the pinch in their budgets.
For now, the primary takeaway from the latest earnings reports is that “there hasn’t been anything new this quarter regarding asset quality,” according to Narron. Strong revenues, profits, and a resilient net interest income suggest a still-healthy banking sector.
“There is some strength in the banking sector that isn’t entirely surprising, but it’s reassuring to see that the foundations of the financial system are robust at this time,” Mulberry concluded. “However, we remain vigilant, as prolonged high interest rates could induce more stress.”