With interest rates currently at their highest levels in over 20 years and inflation continuing to impact consumers, major banks are bracing for increased risks associated with their lending activities.
In the second quarter of this year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their reserves for credit losses compared to the previous quarter. These reserves are funds that banks set aside to cover potential losses arising from credit risks, such as delinquent loans and bad debts, including commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s allowance for credit losses reached $21.8 billion, significantly increasing from the previous quarter; and Wells Fargo contributed $1.24 billion.
These increased reserves indicate that banks are preparing for a potentially riskier environment, where both secured and unsecured loans could lead to larger losses for these financial institutions. A recent study by the New York Federal Reserve reported that Americans currently owe a staggering $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, as consumers deplete their pandemic savings and turn increasingly to credit, credit card issuance and delinquency rates are also rising. In the first quarter of this year, total credit card balances reached $1.02 trillion, marking the second consecutive quarter where total cardholder balances surpassed the trillion-dollar threshold, according to TransUnion. The status of commercial real estate also remains uncertain.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, commented on the ongoing adjustments in banking and consumer health stemming from pandemic stimulus measures.
However, any major issues for banks are expected to arise in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that the reserves reported in any given quarter do not solely reflect recent credit quality but rather banks’ forecasts of future financial conditions.
As banks anticipate a slowdown in economic growth, an increase in unemployment rates, and two potential interest rate cuts later this year, they are preparing for possible delinquencies and defaults as the year comes to a close.
Citigroup’s chief financial officer, Mark Mason, highlighted concerns falling primarily on lower-income consumers, who have experienced significant declines in savings since the pandemic began.
Despite a resilient overall U.S. consumer landscape, Mason noted a disparity in financial performance among different income groups. He observed that only the highest income quartile has managed to save more than they did before 2019, with those in the upper FICO score bracket maintaining spending growth and consistent payment rates. In contrast, consumers with lower credit scores are experiencing significant challenges, borrowing more and facing declining payment rates due to the pressures of rising inflation and interest rates.
The Federal Reserve has maintained interest rates at a high range of 5.25-5.5% as it seeks stability in inflation metrics toward its 2% target before implementing anticipated rate cuts.
Despite banks gearing up for potential defaults later in the year, current default rates do not indicate an impending consumer crisis, according to Mulberry. He is particularly attentive to the differences between homeowners and renters from the pandemic period, noting that homeowners have benefitted from locked-in low fixed rates, whereas renters face higher costs.
With rental prices having surged over 30% nationwide from 2019 to 2023 and grocery expenses increasing by 25%, renters who did not secure low rates are feeling the most financial strain.
For now, the main takeaway from the latest earnings reports is that there have been no significant changes in asset quality. The banking sector continues to show strong revenues, profits, and robust net interest income, suggesting overall healthy operations.
Mulberry expressed a sense of relief that the financial system remains solid, but cautioned that prolonged high interest rates could lead to increased financial stress moving forward.