As interest rates remain at their highest levels in over 20 years and inflation continues to impact consumers, major banks are bracing for increased risks linked to their lending practices.
In their second quarter reports, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their reserves for credit losses compared to the previous quarter. This reserve is intended to cover potential losses arising from credit risks, such as delinquent debts and lending, particularly in commercial real estate.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion by the end of the quarter, marking a significant increase from the prior quarter. Wells Fargo reported a provision of $1.24 billion.
These increased reserves indicate that banks are preparing for a challenging economic environment, where both secured and unsecured loans could lead to greater losses. A recent New York Fed study highlighted that U.S. households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
There has also been an uptick in credit card issuance and delinquency rates as individuals exhaust their pandemic savings and rely more on credit. In the first quarter of this year, credit card balances surpassed $1 trillion for the second consecutive quarter, according to TransUnion. Additionally, the commercial real estate sector remains vulnerable.
As Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted, the banking sector is still dealing with the aftermath of the COVID era, largely influenced by the stimulus measures provided to consumers.
However, any banking challenges are likely to emerge in the coming months. Mark Narron, a senior director at Fitch Ratings, explained that current provisions do not necessarily reflect recent credit quality but rather what banks anticipate will happen in the near future.
Banks expect slowing economic growth and a rise in unemployment, as well as two interest rate cuts anticipated later this year. This scenario could lead to increased delinquencies and defaults by year-end.
Citigroup’s CFO Mark Mason pointed out that the warning signs appear to be especially pronounced among lower-income consumers, who have seen their savings decline since the pandemic.
“While we observe overall resilience among U.S. consumers, we notice disparities in performance based on income and credit scores,” Mason shared in a recent analyst call. “Only the highest income quartile has maintained greater savings compared to early 2019, and customers with scores above 740 are contributing to spending growth and high payment rates. In contrast, lower-scoring customers are experiencing significant declines in payment rates and increasing their borrowing due to the pressures of inflation and high interest rates.”
The Federal Reserve continues to maintain interest rates at a 23-year high of 5.25-5.5% as it awaits stabilization of inflation metrics toward its 2% target before implementing expected rate cuts.
Despite banks’ preparations for potential increases in defaults, current default rates do not indicate an impending consumer crisis, according to Mulberry. He is particularly focused on the differences between those who owned homes during the pandemic and renters.
“Although interest rates have significantly increased since then, homeowners secured low fixed rates on their debt, so they are not experiencing the same level of financial distress,” Mulberry remarked. “Conversely, renters during that time missed out on that opportunity.”
With renting costs having surged over 30% nationally from 2019 to 2023 and grocery prices rising by 25%, renters without locked-in low rates are feeling the financial squeeze the most.
For now, analysts suggest that the current earnings reports do not reveal any alarming changes in asset quality. Positive indicators such as strong revenues and net interest income demonstrate a robust banking sector.
“There’s a level of resilience in the banking sector that may not have been entirely surprising, but it is reassuring that the financial system remains strong and stable at this moment,” Mulberry concluded. “However, we are monitoring the situation closely, as prolonged high interest rates can create additional stress.”