Amid rising interest rates at their highest in over 20 years and persistent inflation impacting consumers, major banks are preparing for increased risks related to their lending operations.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their reserves for credit losses from the previous quarter. These reserves serve as financial buffers against potential losses arising from credit risk, such as delinquent debts and loans, including those tied to commercial real estate.
JPMorgan set aside $3.05 billion for credit losses, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, more than three times higher than its previous quarter’s reserve, and Wells Fargo’s provisions amounted to $1.24 billion.
These increased reserves indicate that banks are preparing for a challenging environment where both secured and unsecured lending could lead to significant losses. A recent report by the New York Federal Reserve revealed that American households currently owe a total of $17.7 trillion across various types of loans, including consumer, student, and mortgage debts.
The rise in credit card issuance is also evident, with delinquency rates climbing as consumers exhaust their pandemic-era savings and increasingly rely on credit. Credit card balances surpassed $1 trillion in the first quarter of this year, marking the second consecutive quarter that this threshold has been crossed, according to TransUnion. Additionally, the commercial real estate sector remains unstable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, highlighted that the current lending environment is influenced by the aftermath of COVID-19 and the immense stimulus efforts directed at consumers.
Experts caution that challenges for banks may emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions do not necessarily reflect recent credit quality; rather, they represent banks’ expectations for the future.
He noted a shift from a historical approach where failing loans drove up provisions, to a modern one largely influenced by macroeconomic forecasts. In the short term, banks anticipate slower economic growth, a higher unemployment rate, and potential interest rate cuts later in the year, which could result in increased delinquencies and defaults.
Citi’s CFO Mark Mason pointed out concerning trends among lower-income consumers who have seen their savings diminish since the pandemic began. He indicated that while the overall U.S. consumer remains resilient, notable disparities exist across income levels and credit scores. Only the highest-income quartile has managed to maintain higher savings than at the start of 2019, with those scoring above 740 on the FICO scale leading in spending growth and high payment rates. In contrast, consumers with lower FICO scores are experiencing more significant declines in payment rates, contributing to their reliance on credit due to inflation and rising interest rates.
As the Federal Reserve maintains interest rates at a 23-year high of 5.25-5.5% while awaiting stabilization in inflation toward its 2% target, banks are bracing for an uptick in defaults. However, Mulberry remarked that current default rates do not yet indicate an impending consumer crisis. He pointed to a division between homeowners and renters, stating that those who secured low fixed rates during the pandemic are shielded from the current financial strain, unlike renters facing escalating costs.
As rents surged by over 30% nationwide from 2019 to 2023 and grocery costs increased by 25%, renters without the benefit of low rates are experiencing considerable financial pressure.
For now, the latest earnings reports suggest stability within the banking sector, with positive indicators like strong revenues and profits. Narron stated that there have been no significant new developments regarding asset quality this quarter, reinforcing the notion of a robust banking system. Mulberry echoed this sentiment, emphasizing that while the financial framework remains sound, the prolonged period of high interest rates could foster additional stress in the future.