With interest rates reaching their highest levels in over 20 years and inflation placing additional pressure on consumers, major banks are gearing up for potential challenges resulting from their lending activities.
JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo have all increased their reserves for credit losses in the second quarter compared to the previous quarter. These reserves are funds set aside by financial institutions to cover possible losses from credit risks, including delinquent debts and commercial real estate loans.
In the second quarter, JPMorgan allocated $3.05 billion for credit losses; Bank of America set aside $1.5 billion; Citigroup raised its allowance for credit losses to $21.8 billion, more than tripling its previous reserve; and Wells Fargo recorded provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a more uncertain financial landscape, where both secured and unsecured loans could lead to significant losses. A recent report from the New York Fed highlighted that Americans collectively owe $17.7 trillion across consumer loans, student loans, and mortgages.
Moreover, credit card issuance and delinquency rates are rising as individuals exhaust their savings from the pandemic and increasingly turn to credit. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter surpassing the trillion-dollar threshold, as reported by TransUnion. The commercial real estate sector also continues to face challenges.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the effects of the COVID-19 pandemic are still influencing consumer finances, particularly due to the stimulus measures provided.
Looking forward, concerns for banks may develop in the upcoming months. Mark Narron, a senior director at Fitch Ratings, explained that the reserves set aside do not necessarily reflect past credit quality but rather banks’ expectations for future trends.
Currently, banks anticipate slowing economic growth, an increase in unemployment rates, and potential interest rate cuts in September and December, which could result in a rise in delinquencies and defaults by year-end.
Citigroup’s CFO, Mark Mason, pointed out that the issues seem to primarily affect lower-income consumers who have seen their savings diminish since the pandemic.
“While we continue to observe a resilient U.S. consumer overall, there is a noticeable divergence in performance across different income and credit score groups,” Mason explained. “Only the highest-income group has managed to increase their savings compared to 2019, while consumers with lower credit scores are experiencing increased borrowing and decreased payment rates.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, waiting for inflation to stabilize at its 2% target before implementing anticipated rate cuts.
Despite the banks’ preparations for a potential increase in defaults later in the year, current default rates do not suggest an emerging consumer crisis, according to Mulberry. He is particularly observing the differences between homeowners and renters from the pandemic era.
While interest rates have indeed increased, homeowners who secured low-fixed rates are not feeling the same financial strain as those who were renting during that time, according to Mulberry. Renters have faced rent increases of over 30% nationwide from 2019 to 2023 and rising grocery costs, resulting in significant budgetary stress.
For now, the key takeaway from the recent earnings reports is that “there was nothing unexpected in terms of asset quality this quarter,” noted Narron. Strong revenues and profits, along with resilient net interest income, indicate a robust banking sector.
“There are still positive signs within the banking industry, and while it may not have been entirely surprising, it is reassuring to note that the financial system remains strong and sound at this time,” Mulberry stated. “However, it is crucial to keep a close eye on the situation, as sustained high interest rates can increase financial strain.”