As interest rates reach levels not seen in over 20 years and inflation continues to pressure consumers, major banks are bracing for increased risks from their lending activities.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all raised their reserves for credit losses. These reserves represent funds that banks set aside to cover potential losses from credit risks, including delinquent debts and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit losses in the second quarter, Bank of America set aside $1.5 billion, Citigroup’s allowance grew to $21.8 billion—more than tripling its reserves from the previous quarter—and Wells Fargo’s provisions amounted to $1.24 billion.
The increased reserves indicate that banks are preparing for a more challenging economic environment where both secured and unsecured loans may lead to higher losses. A recent report from the New York Fed highlighted that U.S. households owe a combined total of $17.7 trillion in consumer loans, student loans, and mortgages.
The issuance of credit cards and subsequent delinquency rates are also climbing as many people deplete the savings accumulated during the pandemic and increasingly rely on credit. Credit card balances reached $1.02 trillion in the first quarter of the year, marking a second consecutive quarter where total balances exceeded the trillion-dollar benchmark, according to TransUnion. Additionally, the commercial real estate sector remains vulnerable.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector is still recovering from the COVID-19 pandemic, largely due to the stimulus measures directed at consumers.
Issues for banks are expected to emerge in the coming months. Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group, pointed out that the provisions reported by banks reflect their expectations for future credit quality rather than serving as indicators of past performance.
Currently, banks are foreseeing slowing economic growth, increasing unemployment rates, and two anticipated interest rate cuts later this year, which could lead to more delinquencies and defaults as 2023 concludes.
Citigroup’s Chief Financial Officer Mark Mason pointed out that warning signs are particularly evident among lower-income consumers who have seen their savings diminish since the pandemic began. He noted that while many consumers remain resilient overall, disparities exist based on credit scores and income levels.
Mason observed that only the highest income quartile has more savings compared to the beginning of 2019, with customers scoring over 740 on the FICO scale driving spending growth and maintaining high payment rates. In contrast, lower FICO customers are experiencing significant declines in payment rates and are 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%, holding off on rate cuts until inflation measures stabilize closer to its 2% target.
Despite banks preparing for more defaults later in the year, Mulberry mentioned that current rates of defaults do not yet indicate a looming consumer crisis. He highlighted the differences between homeowners and renters, noting that homeowners who locked in low fixed rates during the pandemic are not feeling the financial strain as acutely as renters.
Rent prices have increased by more than 30% nationwide from 2019 to 2023, along with a 25% rise in grocery costs during the same timeframe. Renters, lacking the opportunity to secure low rates, are under significant pressure on their monthly budgets.
For now, the latest earnings reports indicate that there are no major concerns regarding asset quality, with strong revenues, profits, and stable net interest income suggesting the banking sector remains robust. Mulberry remarked on the resilience of the financial system but cautioned that prolonged high-interest rates will exert more stress over time.