As interest rates reach levels not seen in over 20 years and inflation continues to affect 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 all reported an increase in their provisions for credit losses compared to the previous quarter. These provisions reflect the funds set aside by banks to cover potential losses from credit risks, including bad debt and lending practices, particularly in commercial real estate.
JPMorgan allocated $3.05 billion for credit losses during the second quarter; Bank of America followed with $1.5 billion; Citigroup reported a total of $21.8 billion in credit loss allowances—more than tripling its reserves from the previous quarter; and Wells Fargo recorded provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a potentially riskier environment where both secured and unsecured loans might lead to greater losses. A recent analysis by the New York Fed highlighted that American households owe a staggering $17.7 trillion across consumer loans, student debt, and mortgages.
Credit card issuance is also on the rise, with delinquency rates climbing as consumers deplete their pandemic-era savings and increasingly depend on credit. In the first quarter of this year, total credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. Meanwhile, the commercial real estate sector remains uncertain.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the situation: “We’re still coming out of this COVID era, and much of the consumer financial health was driven by the stimulus provided to consumers.”
However, any emerging problems within banks will likely surface in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions reported in any quarter may not accurately reflect the immediate credit quality but instead illustrate banks’ expectations for future performance.
In the near term, banks are projecting a slowdown in economic growth, an increase in the unemployment rate, and likely interest rate cuts later this year. This could lead to more delinquencies and defaults as the year comes to a close.
Citi’s chief financial officer, Mark Mason, pointed out that the warning signs seem to be mainly among lower-income consumers, who have seen their savings diminish since the pandemic began. He noted, “While we continue to see an overall resilient U.S. consumer, we also observe a divergence in performance across different income levels and credit scores.”
Currently, only the top income bracket has increased its savings compared to early 2019, with those holding a credit score above 740 boosting spending while maintaining timely payments. In contrast, consumers with lower credit scores are experiencing significant drops in payment rates and are borrowing more as they struggle with high inflation and rising interest rates.
The Federal Reserve continues to maintain interest rates at a peak of 5.25-5.5%, awaiting inflation measures to align more closely with its target of 2% before making anticipated cuts.
Despite banks’ preparations for possible defaults later this year, Mulberry notes that defaults are not currently escalating to levels indicative of a consumer crisis. He highlights a key distinction between homeowners and renters during this time. Homeowners, having locked in low fixed rates, are largely insulated from the current financial pressure, whereas renters are facing heightened stress due to soaring rent prices, which have increased over 30% nationwide since 2019, alongside a 25% rise in grocery costs.
Overall, the latest earnings reports reveal little change in asset quality, according to Narron. Many indicators, including robust revenues, profitability, and healthy net interest income, suggest that the banking sector remains stable.
“There’s some strength in the banking sector that I don’t think was entirely unexpected, but it is reassuring to note that the financial system’s structures are currently strong,” Mulberry remarked. “Nonetheless, we are closely monitoring the situation as sustained high interest rates could lead to increased stress.”