Big banks are bracing for potential risks from their lending practices as interest rates remain at over two-decade highs and inflation pressures consumers. In the second quarter, major financial institutions, including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo, increased their provisions for credit losses. These provisions are funds set aside to cover potential losses associated with credit risks, including delinquent debts.
JPMorgan reported a $3.05 billion provision for credit losses, while Bank of America set aside $1.5 billion. Citigroup raised its allowance for credit losses to $21.8 billion, more than tripling its reserve from the previous quarter. Wells Fargo’s provisions amounted to $1.24 billion. These increases suggest that banks are preparing for a more unstable lending environment, particularly related to both secured and unsecured loans. A recent study indicated that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as consumers deplete pandemic-era savings and increasingly rely on credit. Credit card balances soared to $1.02 trillion in the first quarter, marking the second consecutive quarter that they exceeded the trillion-dollar threshold. Concerns about commercial real estate (CRE) loans persist as well.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the sector is still recovering from the COVID era, largely due to the stimulus provided to consumers.
However, challenges for banks are anticipated in the coming months. Mark Narron from Fitch Ratings highlighted that quarterly provisions reflect banks’ expectations for future credit performance rather than past quality. Currently, banks predict slowing economic growth, rising unemployment, and two interest rate cuts later this year, which could lead to higher delinquency and default rates.
Citi’s chief financial officer, Mark Mason, pointed out that the concerns are predominantly among lower-income consumers, who have seen a decline in savings since the pandemic. He stated that only the top income quartile has maintained or increased savings since 2019, while those in lower credit brackets are witnessing higher borrowing and declining payment rates due to inflation and interest rate strain.
The Federal Reserve is holding interest rates at a 23-year high of 5.25-5.5%, waiting for inflation metrics to stabilize around its 2% target before implementing expected rate cuts.
Despite preparations for possible defaults in the latter half of the year, current default rates do not indicate a consumer crisis. Mulberry emphasized the divide between homeowners and renters, noting that many homeowners locked in low fixed-rate mortgages, while renters are facing significant financial pressure due to rising rents, which increased over 30% from 2019 to 2023, compared to a 25% rise in grocery costs.
The latest earnings report did not indicate new issues concerning asset quality. Strong revenues, profitability, and resilient net interest income signal a healthy banking sector. Mulberry added that while the banking system remains robust, prolonged high interest rates could lead to increased pressure.