As interest rates remain at their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for increased risks related to their lending activities.
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 that banks allocate to cover potential losses from credit risks, which include delinquencies and bad debts, particularly in sectors like commercial real estate (CRE).
JPMorgan set aside $3.05 billion for credit losses during the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, significantly exceeding its reserves from the previous quarter. Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier financial environment, where both secured and unsecured loans may lead to larger losses. A recent report from the New York Federal Reserve revealed that Americans owe a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card usage is also on the rise, with delinquency rates increasing as consumers deplete their pandemic-era savings and turn to credit. In the first quarter of this year, total credit card balances hit $1.02 trillion, marking the second consecutive quarter where this figure surpassed one trillion dollars, according to TransUnion. The CRE market also remains under pressure.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, emphasized the impact of stimulus measures on consumer health during the ongoing transition from the COVID era.
However, challenges for banks are anticipated in the coming months. Mark Narron, a senior director at Fitch Ratings, noted that the provisions banks report reflect their expectations for future conditions rather than recent credit quality.
The banking sector is currently predicting slower economic growth, a rise in unemployment, and two potential interest rate cuts later this year in September and December, which could lead to increased delinquencies and defaults by year-end.
Citi’s Chief Financial Officer Mark Mason highlighted that the warning signs are mainly observed among lower-income consumers, who have experienced a decline in their savings post-pandemic. He pointed out that while the overall U.S. consumer appears resilient, there are notable differences across income levels.
Mason remarked that only the top income quartile has more savings than they did at the start of 2019, with higher FICO score customers contributing to spending growth while lower FICO score customers are borrowing more and seeing a decline in their payment rates due to the pressures of high inflation and interest rates.
The Federal Reserve has kept interest rates steady at a 23-year high of 5.25-5.5% as it waits for inflation to stabilize towards its 2% target before implementing anticipated rate cuts.
Despite banks preparing for potential defaults in the latter part of the year, current default rates do not indicate an imminent consumer crisis, according to Mulberry. He noted a significant disparity between homeowners and renters during the pandemic era.
While interest rates have risen sharply, homeowners who secured low fixed rates are less affected financially than renters, who have faced rising rents that have increased over 30% nationally from 2019 to 2023, along with grocery prices that have surged by 25% during the same period.
Overall, the latest earnings reports suggest that the banking sector remains stable, with no alarming changes in asset quality. Positive indicators, including strong revenues and resilient net interest income, underscore the ongoing health of the banking industry, even as pressure mounts from sustained high interest rates.