Report on the condition of the U.S. banking industry: third quarter, 2004

Federal Reserve Bulletin, Wntr, 2005

Total assets of reporting bank holding companies rose $245 billion (2.5 percent), to just less than $9.9 trillion, in a third quarter that was characterized by continuing merger activity among banking organizations, reactions to changes in the interest rate environment, and tepid financial markets. More than half of the increase in assets ($144 billion) was accounted for by loans, primarily those secured by commercial real estate and those extended under home equity lines of credit and credit cards. The quarter's growth in commercial real estate loans was about evenly divided between construction lending and mortgage loans to finance existing nonfarm business properties. A significant portion of the growth in credit card loans was unrelated to the quarter's lending activity, reflecting instead a reclassification of credit-card-backed assets to loans from the securities portfolio at one large bank holding company as it merged with another company during the quarter. Commercial and industrial loans rose only modestly, primarily in the small-business and middle-market segments.

Other earning assets grew $49 billion (1.4 percent), primarily in assets held for trading purposes but also in short-term and interbank money market instruments. Total holdings of investment securities declined slightly. Securities and money market holdings rose more rapidly at the fifty large companies than at "all other reporting companies" (1.4 percent, compared with 0.6 percent). These holdings have consistently represented a greater share of assets at the fifty large companies (38.0 percent of assets) than at "all other" companies (27.9 percent), a difference that has been attributable to the sizable trading portfolios maintained by the largest institutions.

Deposits grew $166 billion (1.2 percent), with more rapid growth occurring at "all other" companies (2.2 percent, compared with 0.8 percent at the fifty large bank holding companies). Because deposits did not keep pace with growth in total assets, nondeposit borrowings rose $97 billion (or 3.3 percent) overall, chiefly at the fifty large companies.

Equity rose sharply in the quarter ($79 billion, or 10.3 percent), principally because of increases in the unrealized valuation gains on securities, assets denominated in foreign currencies, and certain derivatives holdings that hedge risks of longer-term loans and servicing assets. A lesser influence was revaluation of the assets of banks or other entities acquired during the quarter, accompanied by increases in intangible assets. Accordingly, regulatory capital ratios--which exclude both unrealized valuation changes and capital increases associated with acquisition-related intangible assets--remained largely steady for the quarter.

Net income rebounded to $27.8 billion, an increase of $2.9 billion, or 11.6 percent, from a second quarter that had included large nonrecurring, litigation-related expenses at two of the largest bank holding companies. This significant decline in non-interest expense ($13.0 billion, or 13.0 percent) primarily reflected the presence of the large nonrecurring charges in the second quarter, although the third quarter included some notable nonrecurring expenses at bank holding companies that had recently completed major acquisitions. Non-interest income also fell sharply ($7.0 billion, or 10.0 percent), reflecting weakness in market-sensitive business lines (such as trading, investment banking, venture capital, and asset management) and a continuing slowdown in mortgage banking revenues. Earnings were damped a bit by a modest narrowing of net interest margins (down 0.08 percent, to 3.39 percent of earning assets) attributable to higher short-term interest rates, a less-steep yield curve, and reduced holdings of longer-term (and thus higher-yielding) mortgage pass-through securities. Provisions for credit losses remained modest, as already low nonperforming asset and net charge-off ratios fell further during the quarter. Nonetheless, reporting bank holding companies increased their provisions slightly for the quarter and thus, for the first time in several quarters, their earnings did not benefit from lower credit costs.