Corporations might be getting over their squeamishness about derivatives.
The Office of the Comptroller last week reported a 6.7% rise during the second quarter in the notional value of outstanding derivatives contracts, to $19 trillion.
Using a new measurement, the agency noted that credit exposure of the banks to derivatives risk rose 6%, to $135 billion. The report said nine institutions account for 94% of the notional amount of derivatives.
J.P. Morgan's main banking unit led the field with more than $3.6 trillion in notional value and a credit exposure of $63.4 billion, or 493.9% of risk-based capital, the OCC said.
The report preceded the merger of Chase Manhattan Bank and Chemical Bank. With the merger now complete, Chase Manhattan apparently has the biggest derivatives business. (See chart.)
Since the federal government began tracking such trades in the early 1990s, the average quarterly jump has been about 4.75%, said Mike Brosnan, acting senior deputy comptroller for capital markets.
Experts attributed the surge to a variety of factors, including banks' newfound expertise in using the instruments to guard against interest rate increases. But they also pointed to renewed confidence and sophistication among banks and their clients in dealing with these investments - after some bad experiences two years ago.
Derivatives are contracts that derive their value from the value of some other asset, such as interest rates, stocks, foreign exchange rates, or commodity prices. They are often used to hedge against changes in the value of a corporation's business or portfolio of investments.
These types of contracts caused controversy after clients began suing banks and brokerage firms in 1994, charging that brokers sold them complicated contracts without fully explaining the potential for financial loss.
Since then, many derivatives buyers have shied away from high-yield, high-risk contracts in favor of "plain vanilla" deals.
"I can confirm that banks are using fewer highly leveraged or exotic derivatives than before," said Mr. Brosnan . "There are still customers who want them, but it's a small percentage and we're seeing less."
Andrew Lese, vice president at Emcore Risk Management Consulting, Irvington, N.Y., said that the higher-than-normal derivatives activity might mean that banks have learned to use derivatives to help one another cope with a volatile bond market.
Bond interest rates rose to 7% from 6% during the second quarter, enough to make banks consider contracts to hedge against future rate volatility, Mr. Lese said.
"Generally when there's a change in interest rates, there's going to be an increase in trading volume, particularly with the larger financial institutions," he said.
Interest rate contracts were by far the most commonly used instrument, accounting for 65% of the dollar value of the top nine banks' derivatives deals.
According to the report, futures and forward contracts accounted for 43% of the dollar value of derivatives deals entered by the top nine banks. Swaps accounted for 35%, and options for 22%.
The OCC's report, based on bank reports filed with the government, rates the notional values of banks' derivatives activity contracts. Notional value measures how much the parties in these contracts potentially have to pay, but does not gauge the amount of capital actually invested in the contracts.
Notional value offers only a crude look at derivatives activity, since it fails to account for the length or riskiness of derivatives contracts.
The OCC report tries to offer a glimpse into the contract's length and risk by measuring banks' credit exposure from all contracts and the amount of capital banks have put at stake in these contracts.
