With interest rates at their highest in over 20 years and inflation putting pressure on 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 stemming from credit risks, including bad debts and delinquent loans, particularly in commercial real estate (CRE).
For the second quarter, JPMorgan set aside $3.05 billion for credit losses; Bank of America allocated $1.5 billion; Citigroup had a total allowance for credit losses of $21.8 billion—more than tripling its reserves from the previous quarter; and Wells Fargo set aside $1.24 billion.
These increased provisions indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans could lead to significant losses. According to a recent study by the New York Federal Reserve, Americans currently owe $17.7 trillion across consumer loans, student loans, and mortgages.
Credit card use and delinquency rates are rising as consumers deplete their pandemic savings and increasingly rely on credit. Outstanding credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter in which total balances exceeded the trillion-dollar threshold, as reported by TransUnion. The commercial real estate sector also remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked, “We’re still navigating the aftermath of the COVID era, largely influenced by the stimulus provided to consumers.”
However, any challenges for banks may emerge in the upcoming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, noted that quarterly provisions typically reflect banks’ expectations for the future rather than real credit quality from the previous three months.
“As we’ve transitioned to a system driven by macroeconomic forecasts, provisions are now more predictive of what banks anticipate rather than reactive to current loan performance,” Narron said.
In the short term, banks are anticipating slow economic growth, rising unemployment, and two interest rate cuts later this year, likely in September and December. This could lead to more delinquencies and defaults as the year concludes.
Citigroup’s CFO Mark Mason highlighted that these warning signs are mainly observed among lower-income consumers, who have seen their savings diminish since the pandemic began.
“While the overall U.S. consumer remains resilient, we observe significant discrepancies in performance among different FICO and income brackets,” Mason explained during an analyst call. “Analysis shows that only the highest income earners have more savings now than in early 2019, with the upper FICO score clients driving increased spending and maintaining high payment rates. In contrast, lower FICO score customers are experiencing a notable decline in payment rates and are borrowing more due to the pressures of rising inflation and interest rates.”
The Federal Reserve has maintained interest rates between 5.25% and 5.5% for 23 years, awaiting a stabilization in inflation before implementing the anticipated rate cuts.
Although banks are gearing up for a potential rise in defaults later this year, currently, defaults are not escalating at a level indicative of a consumer crisis, according to Mulberry. He is particularly focused on the distinction between homeowners and renters.
“Although interest rates have surged significantly, homeowners benefitted from locking in low fixed rates on their debt, allowing them to escape much of the pain,” Mulberry noted. “In contrast, renters who didn’t have this opportunity are feeling the strain.”
With rents increasing over 30% nationwide and grocery costs rising by 25% from 2019 to 2023, renters are facing more pressure on their budgets as these prices outpace wage growth.
For now, the latest earnings reports signal that there are no significant issues in asset quality. According to Narron, the banking sector is displaying strong revenues, profits, and robust net interest income, suggesting ongoing health in the industry.
“There’s a degree of stability within the banking sector that might not have been totally unexpected, but it’s reassuring to see that the financial system’s foundation remains strong,” Mulberry said. “However, as interest rates remain elevated, we are monitoring the situation closely for potential stress.”