US banks are tightening their belts as they face increasing difficulty collecting on debts, particularly in the areas of credit cards, auto loans, and commercial real estate. According to data from the Federal Reserve, the share of past-due debt in these categories has climbed above pre-pandemic levels, forcing banks to take precautions.
The amount of debt that banks have had to write off as a loss due to non-collection has also surged, with charge-off rates for credit card and auto loans reaching their highest levels in more than a decade.
Banks Boosting Reserves
In response, major banks like Wells Fargo, Bank of America, JPMorgan, and Citigroup are setting aside more cash to cover potential loan losses. Since June 2022, Wells Fargo has increased its reserves by about $1.8 billion, and Bank of America by $2.4 billion. Although these reserves are growing, they remain lighter than they were during the Great Recession.
Industry experts say this move reflects banks’ growing concern about the rise in bad loans and the potential for more delinquencies as consumers and businesses struggle with inflation, rising interest rates, and other economic pressures.
America’s Three Debt Pain Points
Each month, the New York Fed surveys around 1,300 Americans, asking them about their likelihood of missing a minimum debt payment within the next three months. Aside from the pandemic period, Americans haven’t been this worried about their financial outlook since 2017.
Here’s a closer look at the three types of debt causing the most concern:
- Credit Card Debt
As of the second quarter of 2023, over 3% of all credit card accounts in the US had past-due balances, a significant rise from less than 2% in 2021. Credit counselor Bruce McClary noted that many people are now struggling to repay their credit card debt while continuing to rely on what remains of their available credit. This can lead to more missed payments and increased debt collection efforts.
David Schiff, a senior managing director at FTI, warned that ongoing repayment issues could pose a larger risk to the overall economy. He highlighted growing concerns around the commercial real estate market and the rapid increase in revolving credit card balances.
- Auto Debt
Auto loan delinquency rates have also spiked above pre-pandemic levels, according to a September 2023 report by the Federal Reserve. The rising cost of monthly payments is a major factor, with many Americans now owing more on their cars than the vehicles are worth. This trend has led to greater financial risk for banks, as repossessed cars often fail to cover the remaining balance on defaulted loans.
Stephen Biggar, director of financial-services research at Argus Research, emphasized that while the increase in auto delinquencies isn’t a sudden crisis, it does present concerns about future debt repayment trends.
- Commercial Real Estate Debt
Commercial real estate is another sector where banks are feeling the strain. Many businesses, particularly those with office space loans, are struggling to repay their debts. High vacancy rates and elevated interest rates have created a challenging environment for office, retail, hotel, and apartment-building properties.
As loans come due, businesses are forced to refinance at much higher interest rates, further squeezing their ability to make payments. While some banks are still restoring reserves that were drawn down during the pandemic, others are preparing for a potential increase in defaults if the economy slows down or unemployment rises.
A Cautious Outlook for the Economy
Though the situation is not yet a crisis, banks are keeping a close eye on debt levels and consumer behavior. Wall Street executives, while generally positive about the overall economy, have acknowledged that rising prices and interest rates are putting pressure on American consumers.
Jane Fraser, CEO of Citigroup, noted that while most customers are managing their finances well, there are signs of stress among lower-income individuals. Brian Moynihan, CEO of Bank of America, echoed this, saying consumers are worried about the cost of living and higher interest rates.
Jeremy Barnum, CFO of JPMorgan, pointed out that discretionary spending has returned to more normal levels after a period of high spending during the pandemic. However, Stephen Biggar emphasized that lower-income Americans are still struggling, with many unable to make ends meet.
Looking ahead, many banks may continue adding to their reserves, especially if the unemployment rate rises. While the jobless rate has stabilized recently, any further increase could push banks to bolster their defenses against potential loan losses.
For now, US banks are taking cautious steps to protect themselves from an uncertain economic landscape, all while hoping that the worst-case scenarios don’t materialize.