As interest rates reach levels not seen in over two decades and inflation continues to impact consumers, major banks are bracing for potential risks associated with 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 funds that banks set aside to mitigate possible losses from credit risks, including defaults on loans such as 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 reserves totaled $21.8 billion, more than tripling its previous quarter’s allowance, and Wells Fargo added $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans risk incurring larger losses. A recent New York Fed analysis revealed that Americans collectively owe $17.7 trillion in consumer and mortgage loans.
Additionally, the number of credit cards issued, along with delinquency rates, is rising as consumers exhaust their pandemic-era savings and depend more on credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter over the trillion-dollar threshold, as reported by TransUnion. Commercial real estate also remains under significant strain.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted, “We’re still emerging from the COVID era, and consumer banking health largely depended on the stimulus provided to households.”
Challenges for banks are anticipated in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions reflect the banks’ expectations for future credit quality rather than past performance.
“It’s interesting because we’ve shifted from a system where increasing delinquencies drove up provisions to one where macroeconomic forecasts primarily dictate provisioning,” Narron stated.
In the short term, banks expect slower economic growth, a rise in unemployment, and two anticipated interest rate cuts later this year, which may lead to more delinquencies and defaults.
Citigroup’s CFO Mark Mason highlighted that emerging risks are primarily affecting lower-income consumers, who have seen their savings dwindle post-pandemic. “There’s a divergence in performance across income levels and credit scores. Only the highest income quartile has maintained their savings since 2019,” Mason indicated.
The Federal Reserve has held interest rates between 5.25% and 5.5% for 23 years, awaiting stabilization in inflation rates before implementing expected cuts.
Despite banks anticipating more defaults as the year progresses, Mulberry pointed out that current default rates do not suggest an impending consumer crisis. He is focused on the divide between homeowners and renters since the pandemic. Homeowners, who locked in low fixed rates on their mortgages, are less affected by rising rates than renters, who have faced skyrocketing rents.
The rental market has surged by over 30% nationally from 2019 to 2023, and grocery prices have increased by 25%, posing significant challenges for renters who have not benefitted from low-rate mortgages.
Overall, the latest earnings reports convey that there are no alarmingly negative trends regarding asset quality at this moment. Positive indicators, such as strong revenue and profits, suggest a resilient banking sector.
“There remains stability within the banking sector, which is reassuring. However, we must closely monitor how ongoing high-interest rates impact financial stress,” Mulberry said.