Publications:
Quarterly Derivatives Fact Sheet -- Third Quarter 1997

RISK

Notional amounts are helpful in measuring the level and trends of derivatives activity. However, these amounts may be a misleading indicator of risk exposure. Data such as fair values and credit risk exposures are more useful for analyzing point-in-time risk exposure, while data such as trading revenues and contractual maturities provide more meaningful information on trends in risk exposure.

The notional amount of credit derivatives reported by insured commercial banks increased by 50 percent from second quarter levels, totaling $39 billion. Notional amounts for the fourteen commercially insured institutions that sold credit protection (i.e., assumed credit risk) to other parties was $14.7 billion, an increase of $7.3 billion from the second quarter of 1997. The notional amount for the nine commercial banks reporting credit derivatives that bought credit protection (i.e., hedged credit risk) from other parties was $24.1 billion, a $6 billion increase from second quarter. The notional imbalance between the aggregate levels of credit derivatives where banks bought and sold credit protection may result from dealer institutions using credit derivatives to hedge risk in their own credit portfolios. Additionally, dealers may use cash instruments to hedge transactions for which the dealer has purchased credit protection.
[See Tables 1,3.]

Credit exposures are reflected in Table 4. However, that table does not reflect the full effects of bilateral netting on potential future credit exposures (i.e., the add-on component). Under the current 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).

There was a $33 billion increase in the third quarter in total credit exposure from off-balance sheet contracts, to $316 billion. Relative to risk-based capital, total credit exposures for the top eight banks increased slightly, to 6.4 percent of aggregated capital in the third quarter from 6.2 percent in the second quarter. The increase in the dollar amount of total credit exposure appears to be largely due to changes in market rates over the third quarter. Credit exposure would have been significantly higher without the benefit of bilateral netting agreements. The extent of the benefit can be seen by comparing gross positive fair values from Table 6 to the bilaterally-netted current exposures shown on Table 4. [See Table 4, 6.]

Non-performing contracts remained at nominal levels. For all banks, the book value of contracts past due 30 days or more aggregated only $8.1 million, or .003 percent of total credit exposure from derivatives contracts. Data through the third quarter 1997 indicate that banks with derivative contracts reported $59 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 relatively small loss figures reflect both the current healthy economic environment and the generally high credit quality of counterparties and end-users with whom banks presently engage in derivatives transactions, as well as the increased use of collateral.

The Call Report data reflect the significant differences in business strategies among the banks. The preponderance of trading activities, including both customer transactions and proprietary positions, is confined to the very largest banks. The banks with the 25 largest derivatives portfolios hold 95 percent of the contracts for trading purposes, primarily customer service transactions, while the remaining 5 percent are held for their own risk management needs. The trading contracts of these banks represent 93 percent of all notional values in the commercial banking system. Smaller banks tend to limit their use of derivatives to risk management purposes. Banks below the top 25 hold 66 percent of their contracts for purposes other than trading. [See Table 5.]

The gross negative and gross positive fair values of derivatives portfolios are relatively balanced; 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, for derivative contracts held for trading purposes, the eight largest banks have $304 billion in gross positive fair values and $306 billion in gross negative fair values. 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 the effects of positions in portfolios of affiliates.

End-user positions, or derivatives held for risk management purposes, have aggregate gross positive fair values of $9.3 billion, while the gross negative fair value of these contracts aggregated to $7.5 billion. Readers should recognize that these figures are only useful in the context of a more complete analysis of each bank's asset/liability structure and management process. For example, these figures do not reflect the impact of off-setting positions on the balance sheet. [See Table 6.] Next:
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