What We Learned From Big Bank Earnings Friday

Earnings at two of the three large U.S. banks that traditionally launch the financial sector’s quarterly earnings season exceeded investors’ expectations Friday. But their income statements revealed the ongoing toll of higher interest rates and reflected concerns about a cooling economy.

Citigroup (C) surpassed consensus projections with net income that rose 10% from the same period a year ago. But excluding one-time items, profit at both JPMorgan Chase (JPM) and Wells Fargo (WFC) declined from a year ago, even as Wells Fargo also topped analysts’ consensus forecasts.

Shares of all three struggled after they reported earnings. JPMorgan’s shares dropped 1.2%, Citigroup’s fell 1.8% and Wells Fargo’s plunged 6%, making it the biggest decliner on the S&P 500 Friday.

Net interest income, a key driver of banking profitability, fell sequentially from the first quarter at all three banks. Loan balances stagnated or dropped, and all three set aside additional money for potential credit losses.

The results highlight how higher interest rates have turned from a boost to a burden for banks’ profit growth. Moreover, they shed light on concerns banks have going forward as borrowing stalls and the economy slows.

Net Interest Income Weakness

The Federal Reserve’s interest rate hikes beginning in early 2022 initially fueled strong net interest income growth for banks. But eventually, that growth decreased as higher deposit costs caught up with higher loan charges.

Net interest income fell for the second straight quarter at JPMorgan Chase to $22.8 billion, down from $23.1 billion in the first quarter and $24.1 billion in the fourth quarter. Wells Fargo reported a drop to $11.9 billion from $12.2 billion in the first quarter, and Citigroup’s fell marginally to $2.7 billion.

Presumably, highly anticipated Fed rate cuts—perhaps as early as September—could boost net interest income in the near term as deposit costs reset more quickly than some loan rates.

Credit Loss Provisions Boosted

However, rate cuts would signal that the Fed foresees sufficient cooling in the economy to prevent inflation from reigniting. And as the economy cools, concerns about borrowers repaying loans increase.

In the second quarter, JPMorgan set aside $3 billion to cover potential credit losses, up from $1.9 billion in the first quarter. Likewise, Wells Fargo boosted its credit loss coverage to $1.2 billion from $938 million a quarter ago, and it wrote off $1.3 billion in bad loans, $146 million more than the first quarter.

Citigroup’s credit loss provisions increased $112 million sequentially to $2.5 billion—36% more than the same period a year ago.

Large banks, of course, have broader loan books than smaller regional banks, which have greater exposure to the troubled commercial real estate sector. With that in mind, Friday’s results may shine an even brighter light on credit loss provisions for regional banks when they report financial results later this month.

Loan Growth—Or Lack Thereof

As large banks brace for more defaults on existing loans, they’re not lending additional money.

JPMorgan Chase reported $1.3 trillion in loans outstanding in the second quarter, a figure that remained essentially unchanged for the fourth straight quarter. Average loans outstanding at Wells Fargo slipped for the fourth straight quarter to $917 billion, down $11 billion from the first quarter. Loans at Citigroup rose 2% to $688 billion but declined by $1 billion from the end of 2023.

Fed rate cuts could spur loan growth by making borrowing more affordable. The challenge for banks, though, will consist of issuing enough new loans to compensate for the lower interest rates they’ll receive for them.