With interest rates reaching levels not seen in over twenty years and inflation continuing to impact consumers, major banks are bracing for increased risks associated with their lending practices.
In the second quarter, prominent banks such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their reserves to cover potential credit losses compared to the previous quarter. These reserves are crucial for addressing potential losses arising from credit risks, which can include issues related to delinquent debts and loans, particularly in commercial real estate.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, more than tripling their reserve from the previous quarter, and Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier economic landscape, where both secured and unsecured loans could result in significant losses. A recent report from the New York Fed highlighted that American households collectively owe $17.7 trillion across various forms of debt, including consumer loans, student loans, and mortgages.
Additionally, credit card issuance is on the rise, and delinquency rates are also climbing as many consumers deplete their savings accumulated during the pandemic and increasingly rely on credit. Credit card debt reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total cardholder balances exceeded this threshold, as reported by TransUnion. Commercial real estate is also facing challenges.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the banking sector and consumer health are still feeling the aftereffects of the economic stimulus provided during the COVID-19 pandemic.
However, any significant issues for banks may emerge in the future. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, emphasized that the current provisions for credit losses do not necessarily reflect recent credit quality but rather banks’ expectations for the near future.
In the coming months, banks anticipate slower economic growth, a potential rise in unemployment, and expected interest rate cuts later this year in September and December, which could lead to more delinquencies and defaults.
Citi’s chief financial officer Mark Mason pointed out that warning signs appear to be more pronounced among lower-income consumers who have seen their savings diminish since the pandemic started. While the overall U.S. consumer remains relatively resilient, there is noticeable divergence in performance among different income groups.
Mason noted that only the highest-income quartile has managed to maintain or increase their savings since early 2019, with customers holding high credit scores being the primary drivers of spending growth and high payment rates. Conversely, those with lower credit scores are experiencing sharper declines in payment rates while taking on more debt, significantly impacted by elevated inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high between 5.25% and 5.5%, awaiting a stabilization of inflation measures towards its 2% target before proceeding with anticipated rate cuts.
While banks are preparing for possible increases in defaults as the year progresses, current default rates do not indicate an imminent consumer crisis, according to Mulberry. He is particularly observing the distinction between homeowners during the pandemic and renters.
Although interest rates have surged, homeowners who secured low fixed rates on their mortgage debts are largely unaffected by these changes. In contrast, renters during that time missed out on these opportunities and are now facing significant financial challenges as rents have risen over 30% nationwide from 2019 to 2023, while grocery prices also climbed 25%.
Overall, the recent earnings reports suggest that there were no significant new issues regarding asset quality this quarter. Despite facing potential challenges, strong revenues, profits, and resilient net interest income indicate a still-sturdy banking sector. Mulberry expressed relief that the financial system remains robust at this juncture, although he cautioned that sustained high interest rates may lead to increasing pressures in the future.