As interest rates reach their highest levels in over 20 years and inflation strains consumers, major banks are bracing for increased risks in their lending operations.
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 to cover potential losses due to credit risk, such as delinquent debt and loans, including those related to commercial real estate.
JPMorgan allocated $3.05 billion toward credit loss provisions in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, more than tripling its reserve build from the previous quarter, and Wells Fargo reported $1.24 billion in provisions.
These increased reserves signal that banks are preparing for a riskier lending environment, where both secured and unsecured loans may lead to greater losses. A recent New York Federal Reserve analysis indicated that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise as consumers deplete their pandemic-era savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter, marking the second consecutive quarter in which total cardholder balances surpassed the trillion-dollar mark, according to TransUnion. The commercial real estate sector also remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the fallout from the COVID-19 pandemic continues to affect the banking sector and consumer health, particularly due to prior stimulus measures.
Looking forward, potential issues for banks could become apparent in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that the provisions recorded each quarter reflect banks’ expectations for the future rather than recent credit quality.
Currently, banks anticipate slower economic growth, higher unemployment, and two anticipated interest rate cuts later this year in September and December. These factors may contribute to increased delinquencies and defaults as the year progresses.
Citigroup Chief Financial Officer Mark Mason pointed out that the warning signs are particularly evident among lower-income consumers, whose savings have dwindled since the pandemic. He observed that only the highest income quartile has maintained savings above pre-2019 levels, with the increased spending growth driven by customers with FICO scores above 740. In contrast, those in lower FICO brackets are borrowing more and experiencing steep declines in payment rates due to the impact of high inflation and rising interest rates.
The Federal Reserve has kept interest rates at a 23-year high of 5.25-5.5%, awaiting signs that inflation is stabilizing toward the central bank’s 2% target before implementing expected rate cuts.
Despite banks’ preparations for potential defaults later this year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He is particularly observing the differences between homeowners and renters from the pandemic era. While rates have risen significantly, homeowners locked in low fixed rates and are not feeling the pinch as acutely as renters, who are contending with rent increases exceeding 30% nationwide from 2019 to 2023 and grocery costs rising by 25%.
Overall, analysts concluded that there were no significant new developments regarding asset quality during the latest earnings period. Notably, robust revenues, solid profits, and strong net interest income are encouraging signs in the banking sector.
Mulberry emphasized that the banking sector remains fundamentally sound, though the prolonged high interest rates could cause increasing stress moving forward.