As interest rates reach their highest levels in more than two decades and inflation continues to pressure consumers, major banks are taking precautions against potential risks in 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, set aside to cover possible credit risks, are vital for addressing delinquent debts and other lending challenges, such as those related to commercial real estate.
JPMorgan set aside $3.05 billion for credit losses in Q2, while Bank of America reported $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion, tripling their reserves from the previous quarter, and Wells Fargo allocated $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans may lead to heightened losses. A recent analysis from the New York Fed revealed that American households owe approximately $17.7 trillion across various loans, including consumer, student, and mortgage debts.
Furthermore, the issuance of credit cards is rising alongside delinquency rates as pandemic-era savings deplete, forcing consumers to rely more heavily on credit. According to TransUnion, credit card balances in the first quarter reached $1.02 trillion, marking the second consecutive quarter where total balances surpassed the trillion-dollar milestone. The commercial real estate sector also remains in a precarious situation.
“The banking landscape is still emerging from the impacts of COVID, particularly regarding consumer health and spending, which were heavily influenced by stimulus measures,” said Brian Mulberry, a portfolio manager at Zacks Investment Management.
However, many issues within the banking sector are expected to manifest over the coming months. “The provisions recorded in each quarter do not solely reflect credit quality from the preceding three months but are indicative of what banks anticipate happening in the future,” explained Mark Narron, a senior director at Fitch Ratings.
As banks assess the economic forecast, they anticipate slowing growth, an increased unemployment rate, and potential interest rate cuts later this year. This situation may lead to further delinquencies and defaults as the year progresses.
Citi’s CFO Mark Mason noted that caution signals are primarily evident among lower-income consumers, who have seen their savings significantly eroded in recent years. “While the overall U.S. consumer remains resilient, there are stark disparities based on income and credit scores,” Mason stated in a recent analyst call. “Only the highest income quartile has more savings than before 2019, while lower FICO score customers are facing declines in payment rates and increasing borrowing, heavily impacted by inflation and rising interest rates.”
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5% as it awaits stabilization in inflation metrics toward its target of 2% before implementing highly awaited rate cuts.
Despite banks bracing for possible defaults in the latter half of the year, the current default rates do not yet suggest a consumer crisis, according to Mulberry. Observations are ongoing regarding the distinction between homeowners and renters during the pandemic. “While rates have significantly increased, homeowners locked in low fixed rates, so they are not feeling the financial strain as much as renters,” Mulberry noted. “Renters, on the other hand, face increased costs without the benefit of those low rates.”
Increased rents, which have surged over 30% nationally between 2019 and 2023, along with grocery prices rising by 25% during the same timeframe, indicate that renters are under significant financial pressure due to escalating living expenses outpacing wage growth.
For the moment, the most significant takeaway from recent earnings reports is that there have been no major surprises in asset quality this quarter. Strong revenues, profits, and solid net interest income are all encouraging signs for the banking sector’s overall health.
“There remains strength within the banking system that, while perhaps not entirely unexpected, provides reassurance that financial foundations are still robust,” Mulberry concluded. “However, we continue to monitor the situation closely, as prolonged high interest rates could lead to increased stress.”