With interest rates at their highest in over 20 years and inflation significantly affecting consumers, major banks are bracing for increased risks related to their lending activities.
In the second quarter of the year, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their reserves for potential credit losses compared to the previous quarter. These reserves are funds set aside by banks to cover potential losses related to credit risk, which includes delinquency on loans and bad debts, particularly 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 reached $21.8 billion by the end of the quarter, more than tripling its reserves from the previous quarter. Wells Fargo added $1.24 billion to its provisions.
These increased reserves indicate that banks are preparing for a riskier financial landscape, where both secured and unsecured loans could lead to greater losses. A recent report from the New York Federal Reserve showed that American households collectively owe $17.7 trillion in various debts, including consumer and student loans and mortgages.
Credit card issuance and delinquency rates are also on the rise as many consumers deplete their pandemic-era savings and increasingly rely on credit. Credit card balances surpassed $1.02 trillion in the first quarter of this year, making it the second consecutive quarter where totals exceeded the trillion-dollar mark, according to TransUnion. The commercial real estate market also faces uncertainty.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the banking sector is still recovering from the impacts of COVID-19, which were mitigated by significant consumer stimulus measures.
However, analysts suggest that any potential banking issues are more likely to arise in the coming months. Mark Narron, a senior director at Fitch Ratings, stated that the provisions recorded by banks do not necessarily reflect the quality of their credit for the past quarter, but rather their expectations for the future.
He continued, drawing attention to a shift in how provisioning is managed. It used to be that increases in loan defaults led to higher provisions, but now macroeconomic forecasts drive these decisions.
In the short term, banks forecast a slowdown in economic growth, rising unemployment, and anticipate two interest rate cuts later this year, which could lead to higher delinquency and default rates as 2023 comes to a close.
Citi’s CFO Mark Mason highlighted concerns particularly among lower-income consumers, who have seen their savings diminish significantly since the pandemic. He observed a disparity among different income levels, stating that only the highest income quartile has more savings than they did before 2019, with those in lower FICO score brackets experiencing higher drops in payment rates and escalating borrowing due to rising inflation and interest rates.
As the Federal Reserve maintains interest rates at a 23-year high of 5.25-5.5%, it awaits signs of inflation stabilizing toward its target of 2% before enacting anticipated rate cuts.
Despite banks preparing for potential defaults, Mulberry notes that defaults are not currently occurring at a rate indicative of a consumer crisis. He is particularly focused on the differences between homeowners and renters during the pandemic period, highlighting that many homeowners secured low fixed-rate mortgages, shielding them from rising costs.
In contrast, renters, facing substantial increases in rent over the past four years—over 30% from 2019 to 2023—and grocery prices rising 25% during the same timeframe, are experiencing greater financial strain due to wage growth not keeping pace with these costs.
Currently, the key takeaway from the latest earnings reports is that there are no new major issues regarding asset quality. Strong revenues, profits, and robust net interest income suggest that the banking sector remains healthy.
Overall, Mulberry expressed cautious optimism about the banking system’s resilience, while acknowledging that prolonged high-interest rates will increasingly exert pressure on the financial landscape.