With interest rates reaching their highest levels in over two decades and inflation still affecting consumers, major banks are bracing for increased risks associated with their lending practices.
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 are funds that banks set aside to mitigate potential losses from credit risks, such as overdue loans and commercial real estate loans.
JPMorgan set aside $3.05 billion for credit losses in the second quarter, while Bank of America allocated $1.5 billion. Citigroup’s allowance for credit losses rose dramatically to $21.8 billion, more than tripling its reserves from the previous quarter. Wells Fargo recorded $1.24 billion in provisions.
These increased reserves indicate that banks are preparing for a more challenging economic climate, with the possibility of losses from both secured and unsecured loans. A recent New York Fed analysis revealed that Americans hold a total of $17.7 trillion in consumer loans, student loans, and mortgages.
As pandemic savings diminish, credit card issuance and delinquency rates are rising. Credit card balances reached $1.02 trillion in the first quarter of this year, marking the second consecutive quarter where total balances surpassed this threshold, according to TransUnion. Additionally, the commercial real estate sector remains in a vulnerable state.
“We’re still emerging from the COVID period, and much of this pertains to banking and consumer health being influenced by the stimulus provided to consumers,” stated Brian Mulberry, a client portfolio manager at Zacks Investment Management.
However, potential issues for banks may arise in the upcoming months.
“The provisions you observe for any given quarter do not necessarily reflect credit quality for the last three months; they represent banks’ expectations for future developments,” explained Mark Narron, a senior director in Fitch Ratings’ Financial Institutions Group.
Narron noted a shift from a traditional model, where rising loan defaults prompted banks to increase provisions, to one driven by macroeconomic forecasts.
In the near future, banks anticipate slower economic growth, higher unemployment rates, and two expected interest rate cuts later this year. This could result in increased delinquencies and defaults as the year concludes.
Citi’s chief financial officer, Mark Mason, highlighted concerns among lower-income consumers, who have seen their savings decline since the pandemic.
“While we observe an overall resilient U.S. consumer, there is noticeable divergence in performance across different income levels,” Mason noted in a recent analyst call. “Only the highest income quartile maintains more savings than at the beginning of 2019, and it’s the over-740 FICO score customers who are contributing to spending growth and maintaining payment rates. Meanwhile, lower FICO customers are experiencing significant drops 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% while awaiting stabilization of inflation toward its 2% target before implementing expected rate cuts.
Despite banks bracing for increased defaults in the latter half of the year, Mulberry emphasized that defaults are not yet rising at a rate indicative of a consumer crisis. He is keenly observing the distinction between homeowners and renters during the pandemic.
“Yes, rates have significantly increased since then, but homeowners secured very low fixed rates on their debts, so they are not feeling the same financial strain. Renters, on the other hand, did not have this advantage,” Mulberry explained.
With rents escalating over 30% nationwide between 2019 and 2023, and grocery costs rising by 25% over the same period, renters are facing significant pressures as their budgets are squeezed, unlike those who managed to lock in lower rates.
Overall, the latest earnings report indicated nothing unexpected regarding asset quality. Strong revenues, profits, and resilient net interest income are positive signs for a healthy banking sector.
“There’s a certain resilience within the banking sector that might not have been anticipated, but it’s reassuring to note the financial system remains robust,” Mulberry remarked. “Yet, the longer interest rates stay elevated, the more strain it will place on the system.”