As interest rates remain at their highest levels in over two decades and inflation continues to pressure consumers, major banks are bracing for increased risks stemming from their lending strategies.
In the second quarter, major financial institutions like JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo raised their provisions for credit losses compared to the prior quarter. These provisions represent funds set aside to mitigate potential losses from credit risks, including overdue debts and commercial real estate loans.
JPMorgan allocated $3.05 billion for credit loss provisions in the second quarter; Bank of America set aside $1.5 billion; Citigroup’s allowance reached $21.8 billion, a significant tripling from the previous quarter; while Wells Fargo reported provisions of $1.24 billion.
These reserve increases indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans may lead to heightened losses. According to a recent study from the New York Federal Reserve, total household debt in the U.S. has reached $17.7 trillion, encompassing consumer loans, student loans, and mortgages.
Furthermore, credit card issuance and default rates are on the rise as individuals deplete their savings from the pandemic and increasingly rely on credit. Credit card balances exceeded $1 trillion for the second consecutive quarter, reflecting a trend noted by TransUnion. The commercial real estate sector also faces instability.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, stated, “We’re still emerging from the COVID era, and the consumer’s banking health has largely relied on the stimulus provided during that time.”
However, challenges for banks are anticipated in the upcoming months. Mark Narron, a senior director at Fitch Ratings, explained that provisions reported each quarter are based on future expectations rather than recent credit performance. “Historically, when loans began to fail, provisions increased; however, we’ve shifted to a model where macroeconomic forecasts are the driving force behind provisioning,” he said.
Looking ahead, banks are predicting a slowdown in economic growth, an uptick in unemployment, and expected interest rate cuts in September and December, potentially leading to more delinquencies and defaults by year-end.
Citi’s Chief Financial Officer Mark Mason highlighted concerning trends among lower-income consumers, who have seen a decrease in savings since the pandemic. “While the overall U.S. consumer remains resilient, we’ve noticed disparities in performance across income levels and credit scores,” he indicated during a call with analysts.
Research shows that only the highest-income quartile has managed to maintain their savings since early 2019, with those having credit scores over 740 driving spending growth and maintaining high payment rates. Conversely, lower FICO score customers are experiencing significant declines in payment rates and are borrowing more due to the pressures of inflation and rising interest rates.
The Federal Reserve is maintaining interest rates at a 23-year peak of 5.25-5.5%, waiting for inflation to stabilize near its target of 2% before implementing anticipated rate cuts.
Despite banks readying for potential defaults in the latter part of the year, current default rates are not escalating to a level that suggests a widespread consumer crisis, according to Mulberry. He is particularly examining the differences between homeowners and renters during the pandemic.
“Homeowners secured very low fixed rates on their debt and are generally not feeling significant financial strain, while renters, who have faced rising rents without the benefit of low-rate locks, are experiencing increased pressure in their budgets,” he noted.
For now, the latest earnings reports show that the banking sector remains in a strong position, with robust revenues and profits indicating ongoing health within the industry. Narron affirmed that “there were no significant new concerns regarding asset quality this quarter,” suggesting a stable financial environment despite the stresses from sustained high interest rates that could lead to further challenges.