In the current economic landscape, with interest rates at their highest in over two decades and inflation pressuring consumers, major banks are bracing for increased risks associated with their lending operations.
In the second quarter, prominent financial institutions such as JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo elevated their reserves for credit losses compared to the previous quarter. These reserves are essential for covering potential losses stemming from delinquent debts and risky lending sectors, including commercial real estate.
JPMorgan set aside $3.05 billion for credit losses, whereas Bank of America allocated $1.5 billion. Citigroup’s allowance amounted to $21.8 billion, more than tripling its reserve from previous quarters. Wells Fargo recorded provisions of $1.24 billion.
This buildup of reserves indicates that banks are preparing for a more challenging economic climate, where both secured and unsecured loans could lead to significant losses. A report from the New York Federal Reserve revealed that American households owe a combined $17.7 trillion in consumer loans, student loans, and mortgages.
Additionally, credit card issuance and delinquency rates are increasing as consumers deplete their pandemic-era savings and turn more to credit. The total credit card balances reached $1.02 trillion in the first quarter, marking the second consecutive quarter where totals exceeded the trillion-dollar threshold, according to TransUnion. The commercial real estate sector also remains vulnerable.
According to Brian Mulberry, a portfolio manager at Zacks Investment Management, the ongoing challenges are rooted in the aftermath of the COVID-19 pandemic, which saw significant consumer stimulus efforts.
Experts note that the provisions reported by banks reflect future expectations rather than recent credit quality. Mark Narron, a senior director at Fitch Ratings, emphasized that these provisions are increasingly driven by macroeconomic forecasts rather than past loan performance.
In the short term, banks predict slowing economic growth and an uptick in unemployment, along with anticipated interest rate cuts in September and December. Such conditions could lead to increased delinquencies and defaults as the year draws to a close.
Citi’s CFO Mark Mason highlighted that emerging risks appear to be primarily affecting lower-income consumers, whose savings have declined since the pandemic began. While the overall U.S. consumer remains resilient, he noted a noticeable disparity in performance based on income and credit scores. Only the top income quartile has maintained savings above pre-pandemic levels.
The Federal Reserve has maintained interest rates at a 23-year high of 5.25-5.5%, awaiting signs of inflation stabilization before implementing any rate cuts.
While banks are preparing for potential defaults, they have not yet seen alarming increases that would suggest a consumer crisis. Mulberry pointed out that homeowners who secured low fixed-rate mortgages during the pandemic are not yet feeling the financial strain, unlike renters facing rising costs.
Rent prices have surged over 30% nationwide from 2019 to 2023, and grocery costs have increased by 25%, placing significant pressure on renters whose wages have not kept pace.
Overall, the latest earnings reports reveal no significant changes in asset quality and suggest that the banking sector remains robust, characterized by strong revenues and net interest income. Mulberry noted the strength of the financial system but warned that prolonged high-interest rates could introduce stress to the sector.