Amid high interest rates and persistent inflation, major American banks are gearing up for increased risks in their lending practices.
In the second quarter, financial giants JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their provisions for credit losses compared to the previous quarter. These provisions are reserves set aside by banks to offset potential losses from credit risks, including unpaid debts and loans, particularly in commercial real estate.
Specifically, JPMorgan allocated $3.05 billion, Bank of America set aside $1.5 billion, Citi’s allowance reached $21.8 billion—more than tripling its reserve build from the previous quarter—and Wells Fargo recorded provisions of $1.24 billion.
This buildup indicates that banks are preparing for a potentially riskier environment, where both secured and unsecured loans may result in more significant losses. A recent study by the New York Fed revealed that Americans collectively owe $17.7 trillion in various forms of consumer debt, including loans and mortgages.
There has also been an uptick in credit card issuances and related delinquency rates, as many consumers are depleting their pandemic-era savings and increasingly relying on credit. According to TransUnion, total credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter that balances surpassed the trillion-dollar threshold. The commercial real estate sector remains particularly vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector is still navigating the aftermath of the COVID-19 pandemic, where stimulus efforts significantly impacted consumer health.
The challenges for banks are expected to come in the future. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that current provisions do not solely reflect past credit quality but rather banks’ expectations for the future. He pointed out a shift from a system that responds to bad loans to one driven by macroeconomic forecasts.
In the short term, banks anticipate slower economic growth, a rising unemployment rate, and potential interest rate cuts in September and December, which could lead to increased delinquencies and defaults by the year’s end.
Citi’s chief financial officer, Mark Mason, remarked that warning signs are emerging among lower-income consumers, whose savings have diminished since the pandemic began. He noted that the highest-income quartile is the only group seeing an increase in savings since early 2019, while consumers with lower credit scores are experiencing more financial strain.
The Federal Reserve has set interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation measures before making anticipated rate cuts.
Despite preparations for a potential rise in defaults later this year, Mulberry indicated that current default rates do not show signs of an impending consumer crisis. He is particularly focused on the distinction between homeowners who secured low fixed-rate mortgages during the pandemic and renters who are now facing significantly increased rental costs.
Currently, renters are experiencing more financial pressure than homeowners, who locked in lower rates. Nationwide, rental prices have risen over 30% from 2019 to 2023, along with a 25% increase in grocery costs during the same timeframe.
Overall, the recent earnings reports revealed no significant changes in asset quality. Strong revenues and profits, along with solid net interest income, suggest a resilient banking sector. However, Mulberry cautions that continued high interest rates could add to financial stress in the longer term.