Report on the condition of the U.S. Banking Industry: Second Quarter, 2005.

Assets at reporting bank holding companies rose $234.6 billion in the second quarter, with loan growth accounting for $163.5 billion, or almost 70 percent of the increase in assets over the period. Aggregate assets of reporting bank holding companies reached $10.9 trillion, 2.2 percent higher than in the first quarter. Figures for the second quarter do not reflect any possible repercussions of the summer Gulf Coast hurricanes, which occurred after June 2005.

The strong 3.2 percent increase in loans occurred mostly in mortgage-related categories, both residential and commercial, and in commercial and industrial loans. A sizable portion of the growth in residential mortgage loans at some institutions was reportedly in adjustable-rate mortgages (ARMs). A significant portion of the growth in residential mortgages reportedly included conventional ARMs and such nontraditional products as "option ARMs" (which allow the borrower to select from a range of payment amounts each month) as well as fixed-rate interest-only loans. To some extent, the recently heightened prominence of these nontraditional types of mortgage loans has been associated with recent and significant increases in home values coupled with efforts by lenders and marginally qualified households to arrange financing for home purchases. Bank holding companies continued to favor these adjustable-rate loans amid market expectations of future increases in interest rates. The growth in commercial real estate lending included substantial increases in construction and land development loans, some of which were used to finance the construction of new homes. Unused commitments to lend rose somewhat more slowly, at 2.6 percent.

Securities and money market assets increased $31.0 billion, or 0.8 percent, much less rapidly than loans. At the fifty large bank holding companies, holdings of these assets rose $66.7 billion (2.2 percent), with much of the increase occurring in short-term instruments. Securities and money market assets declined at all other reporting bank holding companies (down $7.5 billion, or 1.6 percent). Most of the decline occurred in mortgage-related securities as these institutions reduced their holdings of fixed-rate securities and used the proceeds of sold and maturing securities to fund loan growth. Declines were also evident at five large bank holding companies for which banking operations represent only a small component of the consolidated entity (not shown separately), and were accompanied by a comparable decrease in borrowings. (1)

A large portion of the growth in total assets at reporting bank holding companies was funded by borrowings rather than deposits, although the pattern of funding growth differed markedly across industry segments. At the fifty large bank holding companies, nondeposit borrowings rose some $128.3 billion, roughly twice as much as deposits ($62.9 billion). In contrast, at all other bank holding companies, which are predominantly smaller firms, deposits rose about $29.7 billion, but borrowings rose only $5.2 billion. These smaller firms appeared to be more willing to reduce their securities holdings than to seek significantly more nondeposit funding to accommodate their asset growth.

Shareholders' equity at reporting bank holding companies rose 3.3 percent ($29.5 billion), outpacing the rate of growth in total assets. Accordingly, regulatory leverage capital ratios improved a few basis points. Total risk-based capital ratios declined, however, as the mix of assets shifted slightly toward loans and away from mortgage securities that are assigned low risk weights in bank capital regulations. Notwithstanding these small changes, regulatory capital ratios overall remained strong for the industry.

Credit quality continued to improve in the second quarter. Nonperforming assets fell to a remarkably low 0.71 percent of loans and related assets, a reduction of 5 basis points from the first quarter. Net chargeoffs declined to 0.52 percent of average loans, also down 5 basis points. Spurred by these further improvements in asset quality, reporting bank holding companies reduced the size of their allowance for loan losses $493 million, or 0.7 percent.

Earnings totaled $32.7 billion for the second quarter, a little lower than in the previous period despite an increase of $1.2 billion in investment securities gains. This small decline was attributable to a 1.3 percent drop in non-interest income--primarily in trading and investment banking revenues--and a 3.6 percent increase in provisions for loan losses to a level that was still slightly below total net chargeoffs.