Rate, Year-2000 Worries Drove Banks to Load Up On Derivatives In 3Q

WASHINGTON - Bankers concerned about rate volatility at the end of the year and uncertainty related to the year-2000 date change moved to hedge their risks in the third quarter, according to the Office of the Comptroller of the Currency's quarterly derivatives report.

"Bank treasurers and chief financial officers chose to take the sleep-well approach and button up their asset and liability structures in advance of the fourth quarter," said Michael L. Brosnan, the agency's deputy comptroller for risk evaluation.

The notional amount of derivatives held by insured commercial banks increased by $2.7 trillion, to $35.7 trillion, in the third quarter.

Though interest rate contracts represent 79% of the total amount of banks' derivatives holdings, they accounted for 96% of the July-to-September increase.

Banks' trading revenues from cash instruments and derivatives activities were flat, declining $35 million, to $2.1 billion. "Revenues were neither notable for being strong nor for being weak in the quarter," Mr. Brosnan said.

"Revenues of about $2 billion have been the norm for several years. Nothing particularly unusual occurred during the quarter to drive it off of that."

Citibank got the biggest bang for its buck, earning $578 million from a notional base of $3.8 trillion.

Chase Manhattan Bank, by comparison, earned $411 million on a much larger base of $12.8 trillion.

Seven institutions hold 95% of the notional value of all derivatives contracts in the banking system. Chase's holdings are by far the largest.

In second place is Morgan Guaranty Trust Co., with $8.9 trillion. The other large players are Bank of America, Citibank, Bank One, and First Union. (Bankers Trust Co., which was bought by Deutsche Bank in June, was also included in the third-quarter calculations.)

The merger of NationsBank and Bank of America made room for First Union among the top seven holders of derivatives contracts.

The Charlotte, N.C., banking company earned $9 million on a notional value base of $510 billion.

Swaps continued to claim an ever-increasing share of the value of all derivative contracts.

They represented a notional value of $17.4 trillion, or 49% of all derivatives in the third quarter, against 38% in the year-earlier period.

"Swaps are a customized contract that banks can tailor to the needs of their customers," Mr. Brosnan noted. He said he expects banks' use of swaps to continue increasing.

Credit derivatives, though still a small fraction of the total, continued to grow rapidly. Their total notional value climbed 11%, to $234 billion.

Banks' credit exposure related to derivatives contracts rose $23 billion, to $387 billion, but chargeoffs remained low. Banks charged off $72 million in credit losses, or 0.02% of their total exposure.

"The quality of credit exposures from derivatives contracts is notably better than banks' commercial credit exposure," Mr. Brosnan said.

Banks' net loan chargeoffs, by comparison, were 0.43% in the quarter.

Mr. Brosnan warned, however, that the days of registering a zero chargeoff rate on derivatives portfolios are probably over. As banks seek to expand their portfolios they are entering contracts with slightly less creditworthy counterparties.

"We expect to see a continued, but slow, migration of this portfolio quality toward that of the typical loan portfolio," Mr. Brosnan said.

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