With interest rates at their highest in over two decades and inflation putting pressure on consumers, major banks are gearing up for increased risks from their lending practices.
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 credit losses, including delinquent or bad debt and loans such as those for commercial real estate (CRE).
JPMorgan added $3.05 billion to its provision for credit losses in the second quarter; Bank of America increased to $1.5 billion; Citi’s allowance for credit losses reached $21.8 billion, more than tripling its reserves from the previous quarter; and Wells Fargo set aside $1.24 billion.
These increased provisions indicate that banks are preparing for a riskier environment where both secured and unsecured loans could lead to larger losses. An analysis by the New York Fed reveals that Americans owe a total of $17.7 trillion on consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also on the rise as people exhaust their pandemic-era savings and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, the second consecutive quarter with balances exceeding a trillion dollars, according to TransUnion. CRE remains in a precarious position as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that banks are still adjusting from the COVID era, when significant stimulus funds were deployed to consumers.
However, any major problems for banks are expected to materialize in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that current provisions reflect banks’ expectations for the future, driven by macroeconomic forecasts rather than just past loan performance.
In the near term, banks are predicting slower economic growth, higher unemployment rates, and two interest rate cuts later this year in September and December, according to Narron. This could lead to more delinquencies and defaults towards the end of the year.
Citi’s Chief Financial Officer Mark Mason highlighted that these concerns are mainly concentrated among lower-income consumers, who have seen their savings diminish post-pandemic.
While there are indications of resilience among U.S. consumers, there remains a divergence in financial behavior across different income and credit score bands. Higher-income consumers have more savings and drive spending growth, while those with lower credit scores are borrowing more and struggling with high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting inflation stabilization towards its 2% target before considering rate cuts.
Despite banks preparing for potential defaults later in the year, current default rates do not yet signal a consumer crisis, Mulberry noted. He pointed to the disparity between homeowners, who locked in low fixed rates during the pandemic, and renters, who are facing the brunt of rising rental and grocery costs without such protections.
For now, the main takeaway from the latest earnings reports is that there were no new developments in asset quality. Strong revenues, profits, and resilient net interest income indicate a still-healthy banking sector.
“There’s strength in the banking sector,” Mulberry remarked. “But we are watching closely, as prolonged high interest rates increase financial stress.”