With interest rates at their highest levels in over two decades and inflation continuing to impact consumers, major banks are preparing for increased risks associated with their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their reserves for potential credit losses compared to the previous quarter. These reserves reflect the funds banks set aside to cover anticipated losses from credit risks, including unpaid debts and loans, particularly in commercial real estate.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, Bank of America reserved $1.5 billion, Citigroup’s total reached $21.8 billion, significantly more than its previous quarter’s reserves, and Wells Fargo set aside $1.24 billion.
These elevated reserves indicate that banks are preparing for a challenging financial landscape where both secured and unsecured loans may lead to larger losses. A recent report from the New York Fed highlighted that Americans collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are rising as individuals deplete their pandemic-era savings and increasingly rely on credit. Credit card balances hit $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total balances surpassed the trillion-dollar threshold, according to TransUnion. The commercial real estate sector remains particularly vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, stated, “We’re still emerging from the COVID era, and concerning banking and consumer health, it has been the stimulus that was provided to consumers.”
Challenges for banks are expected in the upcoming months. Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group, explained that current provisions may not accurately reflect recent credit quality but rather forecast future trends.
Banks anticipate a slowdown in economic growth, a rise in unemployment, and two interest rate cuts expected in September and December, which could lead to more delinquencies and defaults as the year ends.
Citi’s chief financial officer Mark Mason commented that the emerging issues appear concentrated among lower-income consumers, who have seen their savings decrease since the pandemic.
“While we see an overall resilient U.S. consumer, there’s a notable divergence in performance across various income levels and credit scores,” Mason said during a recent analysts’ call. He noted that only the highest income quartile has increased savings since early 2019, with those having credit scores over 740 driving spending growth and maintaining high payment rates. In contrast, lower credit score customers are facing declining payment rates and borrowing more due to the pressures of high inflation and interest rates.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting stabilization in inflation towards its 2% target before implementing anticipated rate cuts.
Despite preparing for potential defaults, current data do not indicate a consumer crisis, Mulberry remarked. He is observing the difference in experiences between homeowners and renters during this period.
“Rates have increased significantly, but homeowners secured low fixed rates on their debt, so they aren’t feeling the pressure as much,” Mulberry explained. “Renters, on the other hand, didn’t have that opportunity.”
With rents having risen over 30% nationally from 2019 to 2023, and grocery costs increasing by 25% during the same period, renters without fixed low rates are facing severe budgetary stress.
Currently, the latest earnings report indicates stability in asset quality. Despite the challenges, robust revenues, profits, and a healthy net interest income mark positive signs for the banking sector.
“There’s underlying strength in the banking sector, which may not have been entirely anticipated, but serves as a relief, showing that the financial system’s foundations remain strong,” Mulberry concluded. “Yet, we are keeping a close eye on the situation, as sustained high interest rates will lead to more pressures.”