Publications:
Quarterly Derivatives Fact Sheet -- First 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.

Data on credit derivatives was reported in the first quarter 1997 call report. Analysts should be cautioned that data on credit derivatives are being reported for the first time, and could contain reporting errors. The notional amount of all credit derivatives for the eight commercially insured institutions that extended credit protection to other parties was $6.85 billion. The notional amount for the seven commercial banks reporting credit derivatives that obtained credit protection from other parties was $12.29 billion. The notional imbalance between aggregate levels of credit derivatives where banks are receivers of protection and banks which provide protection might be explained by the fact that the majority of the banks engaged in credit derivatives are dealer banks, and may be hedging their derivative positions with cash instruments which are on-balance sheet and whose usage is not apparent from this off-balance sheet data. [See tables 1 , 3.]

Credit exposures are reflected in Table 4. However, that table does not reflect the 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). Since available Call Report information may not reflect the full impact of netting on future credit exposure, the total credit exposures reported here are most likely overstated. If a bank has a legally valid bilateral netting arrangements, potential future credit exposure could be decreased.

The first quarter realized a $17 billion increase in total credit exposure from off-balance sheet contracts, to $268 billion. Relative to risk-based capital, total credit exposures for the top eight banks increased slightly, to 241.9 percent of aggregated capital in the first quarter from 236.9 percent in the fourth quarter. The increase in the dollar amount of total credit exposure appears to be largely due to an increase in the volume of derivatives contracts over the first 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 Tables 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 $32 million, or .01 percent of total credit exposure from derivatives contracts. As of the first quarter 1997, banks with derivative contracts reported $2.1 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 94.1 percent of the contracts for trading purposes, primarily customer service transactions, while the remaining 5.9 percent are held for their own risk management needs. The trading contracts of these banks represent 92.4 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 70.9 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 $268.6 billion in gross positive fair values and $269.6 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 $8.9 billion, while the gross negative fair value of these contracts aggregated to $10.7 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. For example, these figures do not reflect the impact of off-setting positions on the balance sheet. [See Table 6.]

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