The government study of derivatives released this week is unlikely to calm the storm that has been swirling around the bank stock market this year.
"I don't think anything is going to clear the air until we have a quarter where bad news surfaces, yet nobody gets crushed," said Nancy A. Bush, regional bank analyst at Brown Brothers Harriman & Co.
Well-Publicized Loss
This quarter, she noted, has been punctuated by rising interest rates and by Procter & Gamble Co.'s $102 million loss on leveraged swaps contracts set up by Bankers Trust New York Corp.
Fears about derivatives have pushed banks active in that business to the bottom of the market performance list. Bankers Trust is down 16% this year; other decliners include Chemical Banking Corp., by 14%; Bane One Corp., by 12.5%; and J.P. Morgan & Co., by 9%.
The General Accounting Office report unveiled Wednesday is probably "only the beginning of a long debate," said George M, Salem, a bank analyst at Prudential Securities Inc.
Mr. Salem thinks the debate is needed "not for massive reform, but to get out more information on the subject. It's too early to regulate something we don't know enough about."
Derivatives, so named because they are financial instruments valued by the performance of an underlying financial instrument, include swaps, futures, forwards, and options.
Concern About Traders
While many banks use the contracts to hedge risks in their own portfolios, the uncertainty is focused on major banks that act as dealers of risk management tools for corporate customers. These banks also trade derivatives contracts among themselves and other dealers.
Analysts believe fears about derivatives already are factored into major bank stock prices.
"The derivatives business of the major banks held up quite well in the first quarter," said Frank R. DeSantis Jr. of DLJ Securities Corp. "I think the downside is very limited in their stocks.
"Despite results that weren't that good, Morgan still posted a 15% return on equity," he said. "Yet it is only selling between seven and eight times expected earnings."
Not too surprisingly, the analysts are united about the need for more disclosure. "We need to know how much of a bank's activities are plain vanilla, something more, or into the exotic realm," said Mr. Salem.
More information is becoming available. This week Salomon Brothers analyst Ethan M. Heisler produced a new study of derivatives at major banks.
Among other things, he found that "derivative contracts for the eight largest U.S. banks grew by $3 trillion in 1993, to $10 trillion currently."
The big banks' credit exposure exceeds their core capital, he said. "but about 80% to 90% of the banks' counterparties are investment grade and are primarily financial institutions of low credit risk."
In addition, he said, "mark-to-market valuations and collateral arrangements further minimize credit risk."
The largest U.S. banks make markets in derivatives that "contribute a substantial portion of their total reported trading revenues," Mr. Heisler said.
Only a small portion of the big banks' derivative portfolio was devoted to interest rate and foreign exchange risk management. Mr. Heisler said, however, that this activity increased their average net interest income by 11% in 1993.
