With interest rates reaching their highest levels in over two decades and inflation continuing to pressure consumers, major banks are bracing for potential risks in their lending activities.
In the second quarter, major banks including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions represent funds banks reserve to cover potential losses linked to credit risks, such as bad debt and delinquent loans, particularly in commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America reserved $1.5 billion. Citigroup’s credit loss allowance rose to $21.8 billion by the end of the quarter, more than tripling its reserve build from the prior quarter, and Wells Fargo established provisions amounting to $1.24 billion.
These provisions indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans may result in more significant losses. A recent analysis from the New York Fed highlighted that Americans currently owe a total of $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also climbing as consumers dip into their pandemic-era savings and increasingly rely on credit. In the first quarter of this year, credit card balances reached $1.02 trillion, marking the second consecutive quarter where total balances exceeded the trillion-dollar threshold, according to TransUnion. Additionally, the CRE sector remains vulnerable.
As Brian Mulberry, a client portfolio manager at Zacks Investment Management, pointed out, the financial landscape is still recovering from the impacts of COVID-19, largely due to government stimulus that supported consumers.
However, the challenges for banks are anticipated to arise in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that the current provisions do not necessarily indicate past credit quality but instead reflect banks’ expectations for future developments.
He explained that the transition has shifted from a reactionary approach—where provisions increase when loans default—to a model driven by macroeconomic forecasts.
In the short term, banks expect a slowdown in economic growth, a rise in unemployment rates, and potential interest rate cuts in September and December, which could lead to more delinquencies and defaults by year-end.
Citi’s chief financial officer Mark Mason highlighted concerning trends, particularly among lower-income consumers who have depleted their savings since the pandemic began. He observed that while the overall U.S. consumer remains resilient, there is a noticeable divide in financial behavior across income and credit score categories.
Only the highest-income quartile has seen an increase in savings since early 2019, and higher credit score customers are driving spending growth while maintaining high payment rates. Conversely, lower credit score individuals are experiencing a decline in payment rates and are borrowing more, feeling the impact of high inflation and interest rates.
The Federal Reserve has sustained interest rates between 5.25% and 5.5% for 23 years as it waits for inflation to stabilize toward its 2% target before implementing anticipated cuts.
Despite banks’ preparations for potential increases in defaults later this year, Mulberry cautioned that defaults have not yet risen to levels indicative of a consumer crisis. He pointed out the divergence between homeowners and renters during the pandemic. Homeowners managed to secure low fixed-rate mortgages, while renters have faced escalating rental costs without similar opportunities.
With rents rising over 30% nationwide from 2019 to 2023 and grocery prices increasing by 25%, renters, who could not lock in low rates, are experiencing significant financial stress.
Nevertheless, the latest earnings reports indicated stability within the banking sector, with no major changes in asset quality. Strong revenues, profits, and net interest income are encouraging signs of a robust banking environment. Mulberry noted, “There’s some strength in the banking sector… but we are watching closely, as prolonged high interest rates may cause more stress.”