Though banks in general took in 60% more trading revenue in the second quarter than a year earlier, community banks were not on the bandwagon.
In reporting the data last week, the Office of the Comptroller of the Currency attributed the overall upswing mostly to derivatives trading.
But "it's very clear that smaller banks are using derivatives primarily for risk-management purposes rather than positioning and trading," said Douglas E. Harris, senior deputy comptroller.
Observers said they expect smaller banks, having been battered by interest-rate volatility in the last year and a half, to resort more to derivatives as interest rate hedges down the road.
Some already have funds in trading assets, but only 44 banks with between $100 million and $500 million in assets reported trading assets as of March 31. Those assets totaled $306 million.
Among those banks, Kentucky-Farmers Bank of Catlettsburg posted the largest first-quarter profit on trading accounts, $6.3 million. Its account totaled nearly $22 million on March 31.
First-half trading profits for the $119 million-asset bank totaled more than $12 million, said Charles M. Russell Jr., chairman and chief executive.
Low loan demand in its market has prompted the bank to develop investment expertise, he said.
In January the Federal Deposit Insurance Corp. ordered Kentucky-Farmers, previously a top-performing bank, to recognize 1994 losses on mortgage- backed securities by putting the securities into a trading account. As a result, the bank restated overall 1994 results to show a net loss, of $16.9 million.
"Our trading assets are basically in what the FDIC would call high-risk CMOs," Mr. Russell said. "We have a tremendous amount of capital to handle it. I would suggest that other community banks, unless they have an awful lot of capital and a lot of expertise, shouldn't even consider doing something like this."
And most don't.
Of the more than 10,000 banks with less than $500 million in assets, only 263 held off-balance-sheet derivatives on March 31, according to Warren Heller, director of research for Veribanc Inc., a Wakefield, Mass., bank rating service. Many of those included subsidiaries of large bank holding companies.
"It's very clear, as you go down the pecking order in size, that use of these instruments drops off dramatically," Mr. Heller said.
Sixty-three banks with between $100 million and $500 million of assets reported first-quarter income from derivatives. The total: $3.25 million.
"When we look at the income numbers, it really tells the story of how they're being used," Mr. Heller said. "$3.2 million across 63 banks isn't much," so most were likely using the derivatives as "insurance policies," or hedges, he said.
One hundred and nine banks in the same asset-size category lost money on derivatives in the first quarter. But the average of these off-balance- sheet losses was only $106,000. This, Mr. Heller said, proves that these smaller banks aren't at great risk.
The numbers suggest that "the amount of irresponsible speculation is between zilch and none," Mr. Heller said.
However, he and other observers said they expect to see more community banks using derivatives in the future.
One reason smaller banks are examining the option more closely, said Barbara T. Kavanagh, senior manager of risk management at KPMG Peat Marwick in Chicago, is that federal agencies have been talking about considering rate risk when evaluating the adequacy of banks' capital.