As interest rates remain at their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for increased risks stemming from 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 are funds set aside by financial institutions to cover potential losses from credit risks, such as bad debts and commercial real estate (CRE) loans.
Specifically, JPMorgan allocated $3.05 billion for credit losses; Bank of America set aside $1.5 billion; Citigroup’s provision reached $21.8 billion, marking a significant increase from the prior quarter; and Wells Fargo recorded $1.24 billion in provisions.
These increased reserves indicate that banks are preparing for a potentially riskier environment, where both secured and unsecured loans could incur larger losses. A recent analysis by the New York Federal Reserve revealed that Americans owe a combined $17.7 trillion in various types of consumer loans, including student loans and mortgages.
In addition, credit card usage and delinquency rates are on the rise as individuals exhaust their pandemic-related savings and increasingly rely on credit. In the first quarter, total credit card balances reached $1.02 trillion, marking the second consecutive quarter where balances surpassed the trillion-dollar threshold, according to TransUnion. The CRE sector also remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked on the lingering effects of the COVID-19 pandemic on banking and consumer health, emphasizing the role of stimulus measures that were provided to consumers.
Experts caution that challenges for banks may arise in the near future. Mark Narron, a senior director at Fitch Ratings, noted that the provisions reported by banks do not solely reflect credit quality over the past few months but are indicative of their expectations for future conditions.
He observed a shift in how banks allocate provisions, where macroeconomic forecasts now play a significant role compared to past practices where rising loan defaults directly influenced provisions.
Currently, banks are predicting a slowdown in economic growth, an increase in unemployment, and potential interest rate cuts later this year, which may lead to further delinquencies and defaults by year-end.
Citi’s CFO Mark Mason pointed out that the financial struggles appear primarily among lower-income consumers who have diminished their savings since the pandemic. He reported that only the highest income quartile has seen an increase in savings since early 2019.
Mason explained that consumers with high credit scores are sustaining their spending and payment rates, while those with lower scores are experiencing greater difficulties, exacerbated by high inflation and interest rates.
The Federal Reserve has maintained interest rates at a two-decade high of 5.25-5.5% while awaiting stabilization in inflation toward its 2% target before considering rate cuts.
Despite these preparations for escalating defaults, existing default rates do not yet signal a consumer crisis, according to Mulberry. He emphasized the difference between homeowners and renters during the pandemic, noting that homeowners benefited from locking in low fixed rates while renters are facing heightened stress due to rising rental costs.
With rental prices increasing by over 30% nationwide between 2019 and 2023, and grocery costs rising 25%, those who did not secure low rates are feeling the financial squeeze the most.
The recent earnings reports indicate that there were no significant changes in asset quality. Strong revenues, profits, and resilient net interest income suggest that the banking sector remains healthy overall.
Mulberry concluded that while the banking system is currently stable, ongoing high-interest rates could lead to increasing stress in the future.