As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks associated with their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the prior quarter. These provisions, which serve as a financial cushion for potential losses from credit risk such as delinquent debts and bad loans—including commercial real estate (CRE) loans—reflect the banks’ concerns about the economic outlook.
JPMorgan set aside $3.05 billion for credit losses, while Bank of America allocated $1.5 billion. Citigroup reported an allowance for credit losses amounting to $21.8 billion, which more than tripled its reserves from the previous quarter. Wells Fargo designated $1.24 billion for this purpose.
These adjustments indicate that banks are preparing for a more perilous lending environment, where both secured and unsecured loans may lead to greater losses. An analysis by the New York Federal Reserve revealed that American households collectively owe $17.7 trillion across various forms of consumer debt, including loans and mortgages.
Credit card issuance and delinquency rates are also increasing as the savings many accumulated during the pandemic begin to dwindle. TransUnion reported that credit card balances hit $1.02 trillion in the first quarter, marking the second consecutive quarter that this total exceeded the trillion-dollar level. Furthermore, the commercial real estate sector remains in a fragile state.
“We are still recovering from the COVID period, particularly regarding banking and consumer health, largely due to stimulus measures that were implemented,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, any banking difficulties are expected to manifest in the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, explained that current provisions are based not on past credit quality but on banks’ future expectations.
He noted a shift from a historical model where increasing loan defaults prompted an increase in provisions to a scenario where macroeconomic forecasts drive these preparations. Banks anticipate slower economic growth, a rise in unemployment, and potential interest rate cuts in September and December, which could lead to further delinquencies and defaults by year-end.
Citi’s chief financial officer, Mark Mason, observed that concerning trends are primarily affecting lower-income consumers, who have seen their savings diminish since the pandemic.
“While the overall U.S. consumer remains resilient, we notice a growing disparity in performance and behavior across different income and credit score levels,” Mason remarked during a recent conference call with analysts. He pointed out that only consumers in the highest income quartile have increased their savings since early 2019, while those in lower income brackets are witnessing declines in payment rates while borrowing more due to the impacts of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, waiting for inflation to stabilize toward its 2% target before implementing any anticipated rate cuts.
Despite the banks’ preparations for an uptick in defaults later this year, Mulberry noted that current default rates do not suggest a looming consumer crisis. He highlighted the distinction between homeowners and renters during the pandemic; while many homeowners secured low fixed-rate mortgages, renters are facing increased financial pressure from rising rents.
With rents skyrocketing over 30% nationally from 2019 to 2023 and grocery costs rising by 25%, renters without access to low rates during the pandemic are now under significant strain, according to Mulberry.
For the time being, the latest earnings reports indicate stability in the banking sector, with no new concerns about asset quality. Strong revenue, profitability, and resilient net interest income continue to signal a healthy banking environment.
“There’s some strength in the banking sector that wasn’t entirely unexpected but is certainly reassuring, confirming that the financial system remains robust and sound,” Mulberry concluded. “However, we are closely monitoring the situation as prolonged high interest rates could lead to increased stress.”