As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are preparing for increased risks associated with their lending practices.
In the second quarter, leading financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their reserves for credit losses compared to the previous quarter. These reserves are amounts set aside to mitigate potential losses from credit risk, which includes bad debts and various types of loans, notably commercial real estate (CRE) loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America reserved $1.5 billion. Citigroup’s reserve for credit losses rose to $21.8 billion at the end of the quarter, reflecting a significant increase from the previous period, and Wells Fargo set aside $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging economic environment, where both secured and unsecured loans may result in larger losses. According to the New York Fed, total household debt in the U.S. has reached an astonishing $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
Credit card usage is rising alongside delinquency rates, as many consumers exhaust their savings accrued during the pandemic and increasingly rely on credit. In the first quarter, credit card balances exceeded $1 trillion for the second straight quarter, according to TransUnion. The CRE sector also faces significant uncertainty.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector is still recovering from the COVID-19 pandemic, with the initial consumer stimulus contributing to a temporary period of resilience.
Nonetheless, challenges for banks are anticipated in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the provisions recorded by banks do not solely reflect past credit quality but also their expectations for future trends.
“Historically, the increase in provisions was a response to rising loan defaults, but now macroeconomic forecasts play a significant role in driving these provisions,” Narron stated.
In the short term, banks expect economic growth to decelerate, an increase in unemployment, and potential interest rate cuts in September and December, which may lead to higher rates of delinquencies and defaults.
Citigroup’s CFO Mark Mason highlighted the concerns among lower-income consumers, who have seen their savings diminish since the pandemic began. He pointed out a disparity in savings behavior, where only the top income quartile holds more savings now than in 2019, with high FICO score customers maintaining increased spending and payment rates. In contrast, those with lower credit scores are experiencing declining payment rates and increased borrowing.
The Federal Reserve’s interest rates are currently at a 23-year high of 5.25-5.5%, as the bank seeks to stabilize inflation around its 2% target before implementing any anticipated cuts.
Despite the banks bracing for an uptick in defaults later this year, Mulberry indicated that current default rates do not yet signal an impending consumer crisis. He noted a significant distinction between homeowners, who often secured low fixed interest rates during the pandemic, and renters, who are now facing increased housing costs.
Rent prices have surged more than 30% nationwide since 2019, along with a 25% rise in grocery costs, placing immense financial strain on renters whose wages have not kept pace.
Overall, the most recent earnings reports from banks indicate stability in asset quality, with resilient revenues, profits, and net interest income reflecting a healthy banking sector at present. Mulberry remarked on the robustness of the financial system while also emphasizing the need for vigilance as high interest rates continue to pose challenges.