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

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

[GRAPHIC OMITTED]

Mortgage-backed securities in investment accounts, which grew 13 percent over the year, rose to a 10.4 percent share of bank assets at the end of the fourth quarter. As with mortgage loans, banks' holdings of mortgage-backed securities followed the swings of long-term interest rates. Banks accumulated mortgage-backed securities at a rapid clip in the first quarter; as longer-term interest rates rose in anticipation of the policy tightening, such holdings shrank in the second quarter, and they fell further in the third quarter. Growth returned strongly in the fourth quarter after rates declined.

From a longer-term perspective, bank involvement in residential mortgage products has increased dramatically over the past twenty years. In 1985, residential mortgages accounted for 7.3 percent of average net consolidated assets, while agency pass-throughs--one type of mortgage-backed security available to investors at the time--were less than 1 percent. By the end of 1995, the share of residential mortgage products on banks' books had risen to 22.2 percent--14.4 percent in mortgages and 7.8 percent in securities. By the end of 2004, banks' asset share of these products had risen to more than 28 percent.

Liabilities

Commercial bank liabilities grew 9.5 percent last year, with all classes of liabilities posting increases. The 8.2 percent growth in core deposits outpaced the previous year's strong advance by about 1 percentage point, but it lagged the expansion in total assets. Some of the run-up in core deposits in the first half of the year was attributable to the decline in mortgage rates in the first quarter (chart 2). The drop in rates led to an increase in refinancing. When securitized mortgages are refinanced, the proceeds are held temporarily in a liquid deposit account before disbursement to the securities holders, thereby boosting deposits for a time; the slower pace of refinancing in the second half of the year diminished this effect to some extent. As a share of total liabilities, savings deposits grew during the four quarters of 2004, while the shares of transaction and small-denomination time deposits fell a bit (chart 11).

[GRAPHIC OMITTED]

With the growth of assets outstripping that of core deposits, banks relied more heavily on managed liabilities--defined as the sum of demand notes issued to the U.S. Treasury and other borrowed money, federal funds purchased and securities sold under repurchase agreements, subordinated notes and debentures, large time deposits, and deposits booked in foreign offices. This sum grew 12.1 percent last year, and its share of total liabilities rose to 39.2 percent. For all banks, large time deposits posted the fastest gain, 21.8 percent; at the ten largest banks, such deposits grew even more rapidly, 30.6 percent.

Banks again expanded their use of Federal Home Loan Bank (FHLB) advances in 2004. (8) These loans grew approximately 3.7 percent last year, about the same rate as in 2003, but well below the growth rate of 17.2 percent in 2002. On average last year, FHLB advances equaled 8.6 percent of total managed liabilities at domestic banks--but the proportion was much higher at medium-sized banks (23.9 percent) and at small banks (22.1 percent).