With interest rates at their highest level in more than two decades and inflation continuing to pressure consumers, major banks are bracing for heightened risks related to their lending activities.
In the second quarter, banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds that financial institutions reserve to address potential losses from credit risk, including unpaid debts and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s credit loss allowance grew to $21.8 billion by the end of the quarter, more than tripling its reserve from the prior quarter. Wells Fargo’s provisions amounted to $1.24 billion.
These increases signal that banks are preparing for a tougher lending environment, where both secured and unsecured loans could lead to more significant losses for some of the largest banks in the country. A recent report from the New York Fed revealed that American households currently owe a collective $17.7 trillion across various types of loans, including consumer and student loans as well as mortgages.
Credit card issuance and delinquency rates are on the rise as individuals deplete their pandemic-era savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where the total surpassed the trillion-dollar threshold, as reported by TransUnion. The commercial real estate sector also remains vulnerable to potential downturns.
“We’re still emerging from the COVID era, and a significant factor has been the stimulus provided to consumers,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
Potential issues for the banks may materialize in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions reflect banks’ expectations for future credit quality rather than past performance.
“Historically, when loans began to fail, provisions would rise; now, macroeconomic forecasts drive provisioning,” Narron noted.
In the short term, banks are anticipating slower economic growth, a rising unemployment rate, and predicted interest rate cuts later this year in September and December. This situation could lead to an increase in delinquencies and defaults as the year concludes.
Citigroup’s CFO Mark Mason pointed out that the warning signs appear more pronounced among lower-income consumers, who have seen their financial reserves diminish since the pandemic began.
“While the U.S. consumer as a whole remains resilient, there is a noticeable disparity in performance and behavior across different income levels,” Mason remarked during a recent analysts’ call.
“Among our clients, only those in the highest income quartile have more savings now compared to early 2019, and it is the high FICO score customers who are driving spending growth and maintaining payment rates. Conversely, customers with lower FICO scores are experiencing a decline in payment rates and are borrowing more due to the effects of high inflation and interest rates.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation measures toward the central bank’s 2% target before implementing the anticipated rate cuts.
Currently, while banks are preparing for increased defaults later in the year, the rate of defaults has not yet suggested a consumer crisis, according to Mulberry. He is particularly observing the contrast between homeowners and renters during this period.
“Yes, rates have risen significantly since then, but homeowners locked in very low fixed rates, so they are not feeling the financial strain as much,” Mulberry commented. “Renters, on the other hand, did not have that advantage.”
With rent prices surging over 30% nationwide and grocery costs climbing 25% from 2019 to 2023, renters who could not secure low rates are facing greater challenges in managing their monthly expenses.
Overall, Mulberry noted that recent earnings reports do not indicate any new issues regarding asset quality. Strong revenues, profits, and resilient net interest income reflect a banking sector that remains largely healthy.
“There’s some strength in the banking sector that may not have been entirely unexpected, but it’s reassuring to see that the financial system’s structure is still robust and sound at this time,” Mulberry said. “However, we are closely monitoring the situation, as the prolonged high interest rates may lead to increased stress.”