As interest rates reach their highest levels in over two decades and inflation continues to pressure consumers, major banks are preparing for increased risks associated with their lending practices.
JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all raised their provisions for credit losses in the second quarter, indicating a cautious approach towards potential loan defaults. Provisions are funds set aside by financial institutions to cover anticipated losses from credit risk, which includes bad debt and commercial real estate loans.
In the second quarter, JPMorgan allocated $3.05 billion for credit loss provisions, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses soared to $21.8 billion, more than tripling its reserves from the previous quarter, and Wells Fargo designated $1.24 billion for this purpose. These increases suggest that banks are anticipating a more challenging environment where both secured and unsecured loans may lead to significant losses.
A recent analysis by the New York Federal Reserve highlights the alarming rate of household debt, which has reached a staggering $17.7 trillion. Credit card usage and delinquency rates are on the rise, driven by waning pandemic-era savings and an increasing reliance on credit. According to TransUnion, credit card balances surpassed $1 trillion for the second consecutive quarter this year, signaling a trend that could pose further challenges for banks.
Brian Mulberry, a client portfolio manager at Zacks Investment Management, noted that the effects of the COVID-19 stimulus are still influencing consumer behavior and the overall health of the banking sector. However, potential issues for banks are expected to emerge in the future. Mark Narron, a senior director at Fitch Ratings, explained that current provisions reflect banks’ expectations, rather than past credit quality, indicating that macroeconomic forecasts are now primarily driving provisioning strategies.
In the immediate future, banks are predicting slower economic growth, rising unemployment rates, and anticipated interest rate cuts in September and December. These factors could contribute to an increase in delinquencies and defaults as the year closes.
Citigroup’s CFO, Mark Mason, pointed out that financial distress appears to be more pronounced among lower-income consumers, who have seen significant declines in savings since the pandemic began. Only the highest-income quartile has managed to increase their savings since early 2019, while consumers with lower credit scores are struggling with increased borrowing and higher rates of missed payments due to inflation and rising interest rates.
Despite the preparedness for wider defaults in the latter half of the year, Mulberry noted that current default rates do not indicate an impending consumer crisis. He highlighted a distinction between homeowners during the pandemic, who locked in low fixed rates, and renters who are now facing significant rental increases. Rents have surged over 30% nationally from 2019 to 2023, alongside a 25% increase in grocery costs, putting additional pressure on those without the financial protection of a fixed mortgage rate.
Overall, the latest earnings reports from major banks indicate stability within the sector, with no significant changes in asset quality. Strong revenues and profits demonstrate a generally healthy banking environment. Mulberry emphasized that while the banking sector remains robust, ongoing high interest rates could lead to increased financial stress over time.