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Quarterly Derivatives Fact Sheet - Second Quarter 1996
Choose Section: General.......Risk....Revenue........High-risk Mortgage Securities and Structured Notes
Risk
Notional amounts are helpful in measuring the level and trends of derivatives activity. However,
these amounts may be misleading indicator of risk exposure. Beginning in the second quarter of
1995, the Call Report provided data that improve disclosure and understanding of the relative
riskiness of bank activities involving derivatives. Some of the data provide immediate
information (e.g., fair values and credit risk positions) while other data will be more useful over
time in evaluating trends (e.g., revenue and contractual maturity data).
In addition to the Call Report changes, the risk-based capital guidelines were amended as of the
second quarter of 1995 to (1) revise and expand the set of conversion factors used to calculate the
potential future credit exposure of derivative contracts, and (2) recognize the effect that
qualifying bilateral netting arrangements will have on the potential future credit exposure for
derivative contracts. Contracts with the longest maturities (i.e., over five years) are now subject
to new, higher conversion factors. New conversion factors were also established that specifically
apply to derivative contracts related to equities, precious metals, and other commodity contracts.
The credit exposure calculations in Table 4 reflect those new factors. However, that table does
not reflect the effects of bilateral netting on potential future credit exposures. Under the new
risk-based capital guidelines, banks have the option of either calculating their netted potential
future credit exposure on a counterparty basis or approximating their netted potential future
credit exposure on an aggregate basis (so long as the method chosen is used consistently and is
subject to examiner review). Since available Call Report information does not reveal the method
chosen by the bank to report the impact of netting on future credit exposure, the total credit
exposures reported here represent upper bounds. If a bank has a legally valid bilateral netting
arrangement, potential future credit exposure could be decreased.
The second quarter saw a $13 billion increase in total credit exposure from off-balance sheet
contracts to $235 billion. Relative to risk-based capital total credit exposures for the top nine
banks averaged 244.1 percent of capital in the second quarter, compared to 233.7 percent at the
end of the first quarter. This increase in exposure is largely due to the growth in derivative
volumes and the related increase in the future add-on portion of the credit exposure calculation.
However, credit exposure would have been significantly higher without the benefit of bilateral
netting agreements. The extent of the benefit can be seen by comparing the gross positive
replacement cost from Table 6 to the bilaterally-netted current exposures shown on Table 4. [See Table 4.]
Non-performing contracts remained at nominal levels. For all banks, the book value of contracts
past due 30 days or more aggregated only $16 million, or .0001 percent of total current exposure
from derivatives contracts. As of the second quarter 1996, banks with derivative contracts
reported $19 million in credit losses from off-balance sheet derivatives. This number represents
the year-to-date charge-offs incurred from off-balance sheet contracts. These figures reflect both
the current healthy economic environment and the relatively high credit quality of counterparties
and end-users with whom banks currently engage in derivatives transactions.
The Call Report data reflect the significant differences in customer bases and business strategies
among the banks. The preponderance of trading activities, including both customer transactions
and proprietary positions, is confined to the very largest banks. Smaller banks tend to limit their
use of derivatives to risk management transactions. The banks with the 25 largest derivatives
portfolios hold 93.6 percent of the contracts for trading purposes, primarily customer service
transactions, while the remaining 6.4 percent are held for their own risk management needs. The
trading contracts of these banks represent 91.5 percent of all notional values in the commercial
banking system. Banks below the top 25, which use derivatives primarily for risk management
transactions, hold 72.7 percent of their contracts for purposes other than trading. [See Table 5.]
The gross negative and gross positive fair values of derivatives portfolios show that banks
continue to maintain relatively balanced books; that is, the value of positions in which the bank
has a gain is not significantly different from the value of those positions with a loss. In fact, the
nine largest banks have $198.4 billion in positive fair values and $198.3 billion in negative fair
values. These figures represent a slight increase from first quarter levels. Note that while gross
fair value data are very useful in depicting more meaningful market risk exposure, users must be
cautioned that these figures do not include the results of cash positions in trading portfolios.
Similarly, the data are reported on a legal entity basis and consequently do not reflect effects of
positions in portfolios of affiliates, and may result in double-counting bank and non-bank
affiliate positions.
End-user positions, or derivatives held for risk management purposes, have aggregate gross
positive fair values of $8.3 billion, while the gross negative fair value of these contracts
aggregated to $9.5 billion. Readers must be cautioned, however, that these figures are only useful
in the context of a more complete analysis of each bank's asset/liability structure and
management process. [See Table 6.]
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