Profits and balance sheet developments at U.S. commercial banks in 2004

Federal Reserve Bulletin, Spring, 2005 by Elizabeth C. Klee, Fabio M. Natalucci

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The moderation in the growth of salaries and benefits was more than offset by a brisk rise in other non-interest expense, which increased about 1.5 percentage points as a share of total revenue, to 26.2 percent. An increase in nonrecurring charges--including merger-related expenses and litigation provisions related to settlements of alleged failures of corporate governance and conflicts of interest--contributed to the rise in other non-interest expense. Non-interest expense also was reportedly boosted somewhat by increased costs for regulatory compliance as banks responded to the Bank Secrecy Act, the USA Patriot Act, and the Sarbanes-Oxley Act.

Loan Performance and Loss Provisioning

The ongoing economic expansion and a further strengthening of household and business balance sheets contributed to the continued improvement of credit quality in 2004 and allowed banks to reduce their provisions for loan and lease losses. The debt-service burden of businesses continued to decline, while the financial obligations ratio of households, although still high, was below the peak reached at the end of 2002 (chart 21). Presumably reflecting these developments, delinquency rates for all major loan categories moved down, with that for C&I loans posting the largest decline. Delinquency rates on both residential and commercial real estate loans moved down further. Net charge-off rates for nearly all types of loans fell, and those for real estate loans dropped to historically low levels. Nonetheless, total net charge-offs surpassed provisioning, and so total reserves for loan and lease losses fell last year. But with asset quality improving, the ratio of reserves to net charge-offs and to delinquent loans both rose.

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C&I Loans

The delinquency rate on C&I loans continued to decline during 2004; by the end of the year, it had fallen 1 percentage point, to 1.9 percent, the lowest level since the first quarter of 1999 (chart 22). The decline was driven primarily by developments at the 100 largest banks, as the substantial increase in such delinquencies at those entities in the aftermath of the 2001 economic slowdown receded. The net charge-off rate on these loans fell sharply, reaching 0.3 percent in the fourth quarter, the lowest level since the first quarter of 1998. As with delinquency rates, the improvement occurred mostly at the 100 largest banks.

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Banks were asked in the October 2004 BLPS about their outlook for C&I loan quality over the next year. The majority of respondents indicated that loan quality was likely to stabilize around current levels if economic activity progressed in line with consensus forecasts, while the remaining banks, on net, expected credit quality to continue to improve.

Commercial Real Estate Loans

The credit quality of commercial real estate loans improved further in 2004, even though rents on office buildings continued to contract (albeit at a slower pace). Vacancy rates in the office sector declined in 2004, although they remained elevated, and vacancy rates on retail properties remained relatively low. The delinquency rate on these loans fell 29 basis points, to 1.1 percent last year (chart 22). The net charge-off rate on such loans moved down during 2004 and, by year-end, was near zero across the banking industry.