As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks stemming from their lending practices.
In the second quarter, leading financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all reported significant increases in their provisions for credit losses compared to the previous quarter. These provisions are funds that banks allocate to cover potential losses related to credit risks, including delinquencies and troubled loans like those in commercial real estate (CRE).
Specifically, JPMorgan set aside $3.05 billion for credit losses; Bank of America reserved $1.5 billion; Citi’s provision reached $21.8 billion, which more than tripled its reserves from the prior quarter; and Wells Fargo allocated $1.24 billion for similar purposes.
These reserve increases indicate that banks are preparing for a potentially more volatile environment, where both secured and unsecured loans may lead to greater losses. Recent data from the New York Federal Reserve highlighted that American households collectively owe around $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, the issuance of credit cards and the associated delinquency rates are beginning to climb as consumers deplete their pandemic-era savings and increasingly rely on credit. According to TransUnion, credit card balances exceeded $1 trillion for the second consecutive quarter, indicating rising financial strain among consumers. The CRE sector also remains vulnerable.
Brian Mulberry, a portfolio manager at Zacks Investment Management, noted that the financial industry is still in recovery from the COVID-19 pandemic, largely thanks to the stimulus efforts that were deployed to support consumers.
However, potential challenges for banks are expected in the coming months. Mark Narron, a senior director at Fitch Ratings, emphasized that the provisions set aside do not only reflect past credit performance but are also based on future expectations.
He remarked on the historical shift in how banks manage provisions, stating that the current model is driven more by macroeconomic forecasts rather than solely by the performance of loans.
In the short term, banks anticipate slowing economic growth, a rise in unemployment, and expected interest rate cuts in September and December. This scenario could result in higher delinquency rates and defaults as the year draws to a close.
Citi’s CFO Mark Mason observed that warning signs are particularly prominent among lower-income consumers, who have seen their savings decrease since the pandemic began. While the overall consumer base appears resilient, differences in performance are revealing critical insights.
Mason highlighted that only the top income quartile has managed to increase their savings since early 2019, with high-FICO score customers driving spending growth and on-time payments. In contrast, those with lower FICO scores are facing declining payment rates and have to borrow more due to the effects of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, in hopes that inflation will stabilize closer to the central bank’s 2% target before implementing anticipated rate cuts.
Despite preparations for potential defaults in the latter half of the year, experts like Mulberry contend that defaults are not rising to a level that suggests an impending consumer crisis. He pointed out the differences in financial burdens between homeowners and renters during the pandemic, noting that homeowners locked in low fixed rates while renters now face significantly higher costs.
Between 2019 and 2023, rents have increased by more than 30% nationwide, while grocery prices rose 25%, placing greater strain on renters who lack the same financial protections as homeowners.
Overall, the recent earnings reports indicate stability within the banking sector, suggesting that “there was nothing new this quarter in terms of asset quality,” according to Narron. Strong revenues, profits, and net interest income signal a healthy banking environment, although prolonged high interest rates may introduce further stress.