WASHINGTONDerivatives
held by U. S. commercial banks increased $4.4 trillion in the second quarter,
to $65.8 trillion, the Office of the Comptroller of the Currency reported today
in its quarterly Bank Derivatives Report.
Uncertainty in
financial markets continues to drive banks and their customers to seek risk
mitigation opportunities through the use of derivatives and the notional
numbers this quarter bear that out, said Kathryn E. Dick, the OCCs Deputy
Comptroller for Risk Evaluation. When
events such as the sudden rise in long-term interest rates at the end of the
last quarter occur, derivatives are often the most efficient and effective tool
for rebalancing portfolios. When used
properly, derivatives are a valuable risk management product to help bank
institutional customers manage a broad array of different risks arising from
common business activities such as securing long-term funding or protecting the
value of importing or exporting commercial goods.
Ms. Dick noted that
while the record notional amount of derivatives is a reasonable reflection of
business activity, it does not represent the amount at risk for commercial
banks. The risk in a derivatives
contract is a function of a number of variables, such as whether counterparties
exchange notional principal, the volatility of the currencies or interest rates
used as the basis for determining contract payments, the maturity and liquidity
of contracts, and the creditworthiness of the counterparties in the
transaction.
The OCC also
reported that earnings attributable to the trading of cash instruments and
derivatives activities increased by $130 million in the three-month period, to
$3.2 billion.
The second quarter
revenue numbers were strong, derived primarily from trading activities in interest
rate contracts and foreign exchange, noted Ms. Dick. This is particularly encouraging as actual trading profitability
continues to be understated due to risk management adjustments, primarily
arising from loan portfolio hedging activities. Credit spreads continued to narrow in the second quarter and as
such, banks saw a decline in the mark-to-market value of their credit
protection. Even though this activity
is hedging and not trading, banks typically report the value changes of their
credit hedges in trading revenues, said Ms. Dick.
The report also
noted that total credit exposure, which consists of both the current
mark-to-market exposure (after netting benefits), as well as potential future
exposure to counterparties, increased $61 billion to $724 billion. Although interest rates started to increase
at the end of the quarter, they were still about 50 basis points lower at the
end of the quarter than at the beginning.
We expect to continue to see large credit exposure numbers for as long
as interest rates remain at historically low levels. The dominance of interest rate contracts in bank trading
portfolios results in credit exposure calculations that are highly sensitive to
changes in interest rates, said Ms. Dick.
Not withstanding
the increase in credit exposure, credit risk performance indicators confirmed
the positive view of credit reflected by narrowing corporate credit
spreads. The report noted that only a
small fraction of derivatives contracts were 30 days or more past due. For all banks, the fair value of contracts
past due 30 days or more totaled only $41 million, or .006 percent of total
credit exposure from derivative contracts.
Derivatives charge-offs for the quarter decreased $4 million to $26
million, and represent .004 percent of total derivative exposures, well below
the .34 percent for C&I loans.
During the second
quarter, the notional amount of interest rate contracts increased by $3.5
trillion, to $56.9 trillion. Foreign
exchange contracts increased by $849 billion to $7.1 trillion. This figure excludes spot foreign exchange
contracts, which increased by $144 billion, to $609 billion. Equity, commodity and other contracts
decreased by $11 billion, to $1 trillion.
Credit derivatives increased by $92 billion, to $802 billion.
The derivatives
business remains largely concentrated in interest rate contracts. Overall, 86 percent of the notional amount
of derivatives positions was comprised of interest rate contracts, with foreign
exchange accounting for an additional 11 percent. Equity, commodity and credit derivatives accounted for only three
percent of the total notional amount.
The number of
commercial banks actively engaging in derivatives remains small. The top seven commercial banks account for
almost 96 percent of the total notional amount of derivatives in the commercial
banking system, with more than 99 percent held by the top 25 banks. These large players have the most
sophisticated risk management systems, high caliber management, and are subject
to close supervision from bank regulators, said Ms. Dick.
The OCC second
quarter derivatives report also noted that:
·
Revenues from foreign exchange positions increased by
$130 million, to $1.5 billion. Revenues
from equity trading positions decreased by $185 million, to $300 million in the
second quarter. Revenues from commodity
and other trading positions decreased by $172 million to a loss of $117
million.
·
The number of commercial banks holding derivatives
increased by 42, to 530.
A copy of OCC
Bank Derivatives Report: Second Quarter 2003 is available on the OCC Web
site: www.occ.treas.gov.
The OCC charters, regulates and examines
approximately 2,100 national banks and 52 federal branches of foreign banks
in the U.S., accounting for more than 55 percent of the nations banking
assets. Its mission is to ensure a safe and sound and competitive national
banking system that supports the citizens, communities and economy of the
United States.