In the second quarter of this year, the US banking industry reported a climb in profits compared to the previous quarter. However, credit quality continued to deteriorate, as mentioned in the Federal Deposit Insurance Corporation's (FDIC) quarterly report.

The mixed performance of the banking sector in the second quarter puts it on stable ground ahead of the Federal Reserve's indication that it will soon start reducing its benchmark interest rate. While the report noted the industry's resilience, FDIC acting Chair Martin Gruenberg also highlighted significant downside risks arising from economic uncertainty, market interest rates, and geopolitical events.

Despite these concerns, aggregate profits increased by 11.4% to reach $71.5 billion compared to the first quarter. However, this figure was slightly lower compared to the same period last year. The rise in profits was mainly attributed to one-time securities gains reported by large banks, as well as the absence of fees owed to the bank regulator for covering the regional bank failures in the previous year.

Credit quality in the industry worsened slightly, with the rate of net charge-offs, or the writing off of bad loans, rising by 3 basis points to 0.68% from the previous quarter. This rate is the highest it has been since the country's last major credit cycle a decade ago, primarily driven by credit card and non-owner-occupied commercial real estate loans.

The share of non-current loans, which are at higher risk of default because they are 90 days past due, remained unchanged and below the average before the pandemic. The increase in bad loans during the second quarter was mainly attributed to credit card and non-owner-occupied commercial real estate loans. Credit card loans held by banks reached their highest rate since the third quarter of 2011.

As the Federal Reserve is poised to lower interest rates later this month, the FDIC report covers what is expected to be the end of a two-year period of tighter monetary policy for the industry. While high rates have resulted in record profits for the biggest players, margins across the sector have been squeezed. The net interest margin, measuring the interest earned minus the interest paid for deposits and other funding sources, declined slightly in the second quarter and remained below its historical average before the pandemic.

Additionally, the industry experienced paper losses of $513 billion on lower-yielding bonds in the second quarter, with regional banks like PNC and Truist recognizing billions in losses to improve their margins ahead of anticipated rate cuts. Lower interest rates are expected to alleviate the profitability drag caused by lower-yielding securities and bonds acquired during the pandemic.

Gruenberg emphasized the importance of monitoring certain loan portfolios such as office properties, credit cards, and multifamily loans due to weakness in those areas.

Overall, the US banking industry's second quarter performance showed promise in terms of increased profits, but the worsening credit quality remains a concerning factor. With the Federal Reserve set to lower interest rates, the industry hopes to mitigate the impact of lower-yielding assets while monitoring loan portfolios closely.