Amidst interest rates climbing to levels not seen in over two decades and inflation exerting pressure on consumers, major banks are gearing up for potential challenges stemming from 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 previous quarter. These reserves are funds set aside to absorb possible losses from loans that could become delinquent or defaulted, especially concerning commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance surged to $21.8 billion, more than tripling its reserves from the prior quarter, and Wells Fargo reported provisions of $1.24 billion.
These increased reserves indicate that banks are preparing for a riskier lending environment, with both secured and unsecured loans posing significant risks. According to a recent New York Fed analysis, total household debt in the U.S. stands at approximately $17.7 trillion across consumer loans, student loans, and mortgages.
The issuance of credit cards, along with rising delinquency rates, has intensified as many individuals exhaust their savings accumulated during the pandemic and increasingly depend on credit for expenses. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter in which total cardholder balances surpassed the trillion-dollar threshold, as reported by TransUnion. The commercial real estate sector also remains under strain.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, remarked on the lasting impact of the COVID-19 era, largely driven by stimulus initiatives directed at consumers.
The forthcoming months may present difficulties for financial institutions, as highlighted by Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group. He explained that quarterly provisions do not necessarily provide an accurate picture of credit quality over the past three months but instead reflect banks’ expectations for future credit risk.
Currently, banks are forecasting a slowdown in economic growth, an increase in the unemployment rate, and anticipatory interest rate cuts in September and December, which could lead to more delinquencies and defaults as the year concludes.
Citi’s chief financial officer Mark Mason pointed to concerns among lower-income consumers, who have experienced a decline in savings since the pandemic. He noted that while the overall U.S. consumer remains resilient, disparities exist based on income levels and credit scores. Only high-income individuals have maintained higher savings levels compared to pre-pandemic figures, while lower credit score customers are facing a decline in payment rates and higher borrowing due to the pressures of inflation and interest rates.
As the Federal Reserve maintains interest rates at a 23-year high of 5.25-5.5%, it awaits inflation to stabilize around a 2% target before considering anticipated rate cuts.
Despite banks bracing for an increase in defaults later in the year, the current data does not indicate an impending consumer crisis, according to Mulberry. He is particularly observing the distinction between homeowners and renters from the pandemic era. While homeowners secured low fixed rates on their mortgages, renters, whose expenses have risen more than 30% since 2019, are feeling the financial squeeze more acutely.
Although concerns linger, the latest earnings reports reveal no significant changes in asset quality, according to Narron. He noted that strong revenue, profitability, and robust net interest income signal a healthy banking sector overall.
Mulberry emphasized the resilience within the banking sector, considering the current strength of financial systems, but cautioned that continued high-interest rates could lead to increased stress on consumers and institutions alike.