As interest rates remain at their highest levels in over 20 years and inflation continues to pressure consumers, major banks are bracing for increased risks associated with their lending activities.
In the second quarter, major financial institutions including JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo increased their reserves for credit losses compared to the prior quarter. These reserves are meant to cover potential losses arising from credit risks, including defaults on loans and delinquencies, particularly in sectors like commercial real estate.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s credit loss allowance reached $21.8 billion at the end of the quarter, more than tripling its previous quarter’s reserves, and Wells Fargo established provisions totaling $1.24 billion.
These increasing reserves indicate that banks are preparing for a more uncertain economic environment, where both secured and unsecured loans could lead to larger losses for the sector. A recent analysis by the New York Federal Reserve revealed that Americans carry a total of $17.7 trillion in debt through consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also seeing an upward trend as consumers 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 during which total cardholder balances exceeded that trillion-dollar threshold. Additionally, the outlook for commercial real estate remains tenuous.
According to Brian Mulberry, a client portfolio manager at Zacks Investment Management, the ongoing effects of COVID-19, particularly the stimulus measures that supported consumers, are still impacting the banking sector.
However, experts warn that challenges for banks may rise in the coming months. Mark Narron, a senior director with Fitch Ratings’ Financial Institutions Group, noted that current provisions do not reflect the past three months but are instead tied to banks’ expectations about future credit quality.
He emphasized the shift from a traditional model, where rising loan defaults would lead to increased provisions, to a system in which macroeconomic conditions guide provisioning strategies.
In the immediate future, banks anticipate a slowdown in economic growth, an increase in unemployment, and the possibility of two interest rate cuts in September and December. Narron suggests that these factors could contribute to a rise in delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, pointed out that the current economic challenges seem to disproportionately affect lower-income consumers, whose savings have diminished since the pandemic. He indicated that while the overall U.S. consumer remains resilient, there is a noticeable disparity in financial behavior based on income and credit score.
“We observe that only the highest income quartile has increased their savings since early 2019, while lower-FICO score customers are struggling, with declining payment rates and increased borrowing, largely due to high inflation and rising interest rates,” Mason explained.
The Federal Reserve maintains interest rates at a 23-year high of 5.25% to 5.5%, awaiting a stabilization of inflation toward the central bank’s target of 2% before considering any cuts.
Despite the preparations 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 divide between homeowners and renters who faced different economic challenges during the pandemic.
“While homeowners have benefited from low fixed rates on their mortgages, renters are exposed to soaring rental prices that have increased more than 30% nationwide from 2019 to 2023, coupled with grocery price hikes of 25% in the same timeframe,” he noted.
Currently, the earnings reports show no significant new trends in asset quality, according to Narron. In fact, robust revenues, profits, and steady net interest income suggest that the banking sector remains fundamentally sound.
“There is a strength in the banking system that, while not entirely unexpected, is reassuring. It indicates that the foundations of the financial system remain strong at this time,” Mulberry stated. “However, we continue to monitor the situation closely, as prolonged high interest rates will inevitably create more stress.”