With interest rates at their highest in over 20 years and inflation impacting consumers, major banks are bracing for potential challenges linked to their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their reserves for credit losses compared to the previous quarter. Such reserves represent the funds banks allocate to cover potential losses from loans that may go bad, including delinquent debts and risks associated with commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America reserved $1.5 billion. Citigroup’s allowance grew to $21.8 billion, significantly increasing from the prior quarter, and Wells Fargo’s provisions reached $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging lending environment, where both secured and unsecured loans could lead to greater losses. The New York Federal Reserve recently reported that Americans owe a total of $17.7 trillion in various forms of consumer debt, including student loans and mortgages.
Amid rising credit card issuance and delinquency rates, consumers are increasingly relying on credit as their savings from the pandemic begin to deplete. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where balances surpassed the trillion-dollar threshold. The commercial real estate sector also remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the effects of the COVID era and corresponding stimulus have shaped the current state of banking and consumer health.
Challenges for banks are expected in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions reflect banks’ expectations for the future rather than past credit quality. He stated that the sector has shifted to a model where macroeconomic forecasts heavily influence provisioning.
Banks expect slowed economic growth, a rising unemployment rate, and two interest rate cuts later this year, which could lead to more delinquencies and defaults as the year progresses.
Citi’s chief financial officer, Mark Mason, highlighted concerns that economic stress appears concentrated among lower-income consumers, whose savings have diminished since the pandemic began.
He pointed out that while the overall U.S. consumer remains resilient, there’s a notable disparity in financial behavior across different income levels. Only those in the highest income quartile have increased their savings since 2019, with higher FICO score customers leading in spending and payment rates. In contrast, those with lower credit scores are facing greater difficulties, grappling with inflation and rising interest rates.
The Federal Reserve is maintaining interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization of inflation towards its 2% goal before considering rate cuts.
Despite banks’ preparations for an uptick in defaults, current data does not suggest a looming consumer crisis. Mulberry is observing the differences between homeowners and renters during this period. Homeowners, having secured low fixed-rate loans, are feeling less financial strain compared to renters, who face escalating rents without the benefit of fixed mortgage rates.
From the recent earnings reports, there are no alarming trends in asset quality, and strong revenues and profits indicate a resilient banking sector. Mulberry expressed relief that the financial system remains robust despite the ongoing high interest rates, although he cautioned that prolonged elevated rates could introduce more stress.