As interest rates remain at over two-decade highs and inflation continues to pressure consumers, major banks are bracing for increased risks related to 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 represent the funds set aside by financial institutions to cover potential losses from bad debts and lending risks, including commercial real estate loans.
Specifically, JPMorgan allocated $3.05 billion for credit losses; Bank of America set aside $1.5 billion; Citigroup’s allowance reached $21.8 billion, significantly increasing from the prior quarter; and Wells Fargo noted provisions of $1.24 billion.
The accumulation of these funds indicates that banks are preparing for a riskier financial climate where losses from both secured and unsecured loans may rise. A recent analysis by the New York Fed shows that American households owe a total of $17.7 trillion across various loans, including consumer and student loans as well as mortgages.
Credit card issuance and delinquency rates are also climbing as consumers deplete their pandemic-era savings and increasingly rely on credit. According to TransUnion, credit card balances hit $1.02 trillion in the first quarter, marking the second consecutive quarter that total balances exceeded the trillion-dollar threshold. The commercial real estate sector also faces significant challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented that the banking sector is still emerging from the COVID-19 pandemic, largely thanks to the stimulus funding that supported consumers.
Challenges for banks are expected in the coming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, noted that the provisions reported by banks are reflective of their outlook rather than immediate credit quality. “The macroeconomic forecast increasingly shapes provisioning,” he said.
Currently, banks anticipate slowing economic growth, a rise in unemployment rates, and potential interest rate cuts later this year, which could heighten delinquencies and defaults by year-end.
Citigroup’s CFO Mark Mason highlighted concerns particularly among lower-income consumers, who have seen their savings diminish over the pandemic period. He remarked that while the overall U.S. consumer remains resilient, there’s a noticeable divide in performance based on income levels and credit scores. Only the top income quartile has more savings now than pre-pandemic, while those with lower FICO scores are experiencing declines in payment rates and are relying more on credit.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, as it awaits inflation levels to stabilize around its 2% target before implementing any anticipated rate cuts.
Despite preparations for potential defaults worsening in the latter half of the year, Mulberry suggests current default rates do not yet indicate a consumer crisis. He is closely monitoring the difference in experiences between homeowners and renters, noting that homeowners who locked in low rates during the pandemic are faring better than renters facing skyrocketing costs.
With rents skyrocketing over 30% nationwide from 2019 to 2023 and grocery prices increasing 25%, renters, particularly those without the benefit of low fixed rates, are facing significant financial pressure, noted Mulberry.
Overall, the latest earnings reports from banks indicate steady asset quality. According to Narron, strong revenues, profits, and net interest income demonstrate a resilient banking sector. “The structures of the financial system are still very strong and sound at this point,” Mulberry added, while cautioning that prolonged high interest rates could lead to increased stress in the economy.