As interest rates reach their highest levels in over two decades and inflation continues to pressure 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 are funds that banks set aside to mitigate potential losses from credit risk, which includes delinquent loans and commercial real estate (CRE) loan defaults.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, more than tripling its reserve from the prior quarter, and Wells Fargo reported provisions of $1.24 billion.
These provisions indicate that banks are preparing for a more volatile lending environment, where both secured and unsecured loans could result in significant losses. A recent report from the New York Federal Reserve highlighted that Americans collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Additionally, credit card usage and delinquency rates are on the rise as consumers deplete their pandemic savings and increasingly rely on credit. Credit card balances exceeded $1 trillion in the first quarter, marking the second consecutive quarter this threshold has been surpassed, according to TransUnion. The CRE sector also remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking system is adapting to the post-COVID economic landscape, which was heavily influenced by stimulus measures.
Experts warn that challenges for banks may emerge in the upcoming months. Mark Narron, a senior director at Fitch Ratings, stated that current provisions reflect future expectations rather than past credit quality.
In the near future, banks anticipate slowing economic growth, a rising unemployment rate, and possible interest rate cuts later this year in September and December. This scenario could lead to increased delinquencies and defaults as the year concludes.
Citi’s CFO Mark Mason highlighted that the signs of financial strain are particularly pronounced among lower-income consumers, who have seen their savings diminish since the pandemic. He noted that only the highest-income quartile has more savings now compared to early 2019, and customers with FICO scores over 740 are driving spending growth while maintaining high payment rates. Conversely, those with lower FICO scores are experiencing notable declines in payment rates and are borrowing more, pressured by elevated inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation toward the target of 2% before implementing anticipated rate cuts.
Despite banks preparing for potential defaults in the latter half of the year, current default rates do not suggest a consumer crisis, according to Mulberry. He is closely monitoring the contrasting situations of homeowners and renters during this period.
While interest rates have significantly increased, homeowners who secured low fixed rates on their loans are largely insulated from immediate financial strain, unlike renters who face soaring rental costs.
Rents increased by over 30% nationwide from 2019 to 2023, alongside a 25% rise in grocery prices, which has put considerable pressure on renters who did not benefit from low rates and are dealing with rental costs outstripping wage growth.
At this point, the recent earnings results indicate that the overall health of the banking sector remains robust, with strong revenues and profits suggesting stability. Mulberry commented that the financial system’s structures are still solid, although ongoing high-interest rates may introduce additional stress.