With interest rates at their highest levels in over 20 years and inflation continuing to pressure consumers, major banks are preparing for increased risks associated with their lending operations.
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. These reserves are financial institutions’ safeguards against potential losses from credit risks, including overdue or non-repayable debts, particularly in commercial real estate (CRE) lending.
JPMorgan set aside $3.05 billion for credit losses, while Bank of America allocated $1.5 billion. Citigroup’s credit loss allowance surged to $21.8 billion, more than tripling its reserves from the prior quarter. Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging economic landscape, where both secured and unsecured loans may lead to greater losses. Recent findings from the New York Federal Reserve revealed that Americans have amassed a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
Moreover, there has been a rise in credit card issuance alongside growing delinquency rates, as consumers are increasingly depending on credit as their pandemic-era savings dwindle. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter in which total balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector continues to be particularly vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted the ongoing effects of the COVID-19 era, especially regarding consumer banking stability, largely due to stimulus measures introduced during the pandemic.
However, challenges for banks are likely to emerge in the coming months.
Mark Narron, a senior director at Fitch Ratings, explained that the provisions banks report quarterly do not solely reflect recent credit quality but are also influenced by their forecasts for the future.
“We’ve transitioned from a system where rising loan defaults drove provisions to one where macroeconomic predictions serve as the basis for provisioning,” he stated.
In the short term, banks anticipate slower economic growth, increased unemployment rates, and two interest rate cuts expected later this year in September and December, indicating a likelihood of more delinquencies and defaults by year-end.
Citigroup’s Chief Financial Officer, Mark Mason, pointed out that these concerns seem particularly focused on lower-income consumers, who have depleted their savings since the pandemic began.
“While the overall U.S. consumer remains resilient, we see a divergence in performance across income levels and credit scores,” Mason noted in a recent analysts’ call.
He observed that “only the highest income quartile has more savings than they did in early 2019, and it’s the over-740 FICO score customers who are fueling spending growth and maintaining high payment rates. In contrast, those with lower FICO scores are experiencing sharper declines in payment rates and borrowing more heavily due to the impact of surging inflation and interest rates.”
The Federal Reserve has maintained interest rates at a range of 5.25-5.5%, the highest in 23 years, as it awaits stabilization in inflation measures toward its 2% target before implementing anticipated rate cuts.
Nevertheless, despite banks bracing for increased defaults later this year, Mulberry commented that defaults have not escalated to a level indicative of a consumer crisis. He is paying close attention to the distinction between homeowners and renters from the pandemic era.
“Homeowners locked in low fixed rates on their debts, so they haven’t felt the financial strain as acutely as renters,” Mulberry said. “Renters, facing more than a 30% rise in rents between 2019 and 2023 and a 25% increase in grocery costs during the same timeframe, are the ones feeling the most pressure on their budgets.”
Despite these challenges, the latest earnings reports indicate that “there were no significant new developments this quarter regarding asset quality.” Strong revenues, profits, and resilient net interest income suggest a generally healthy banking sector.
“There’s strength in the banking sector that may not have been entirely unexpected. It’s comforting to confirm that the financial system remains robust and sound at this time,” Mulberry concluded. “However, we are closely monitoring the situation, as prolonged high interest rates could lead to increasing stress.”