WASHINGTON - Bank profits from derivative contracts in the first quarter rose 45% from the previous period, to a record $4 billion, thanks largely to transactions related to corporate debt offerings, the Office of the Comptroller of the Currency reported Monday.
Michael Brosnan, deputy comptroller for risk evaluation, attributed the "eye-popping" gain to business from corporations, which issued large amounts of fixed-rate debt and then turned to banks to convert much of that to floating-rate debt to hedge against losses. Corporations are vulnerable to interest rate changes, so they buy swaps to lock in spreads, Mr. Brosnan explained.
The seven largest banks in the derivatives business, which represent nearly the entire market, significantly exceeded their four-year average shares of gross revenue from derivatives earnings.
Morgan Guaranty Trust Co., for instance, has earned 20% of its gross revenue from derivatives since the first quarter of 1997, but in this year's first quarter it took in 23.5% from that source. Bank of America Corp.'s derivatives revenue jumped from 2.3% to 4.1% of gross revenue. Chase Manhattan Bank, which had averaged 7.4%, tallied 9%, and Citibank earned 10.7% of its gross revenue from derivatives, compared with its four-year average of 7.2%.
Businesses and individuals alike use derivatives to hedge against price fluctuations of almost any asset, such as currencies and commodities.
The notional amount of interest rate contracts, $35.7 trillion, was the bulk of derivatives contracts; foreign exchange positions totaled $6.8 trillion. Commodity, equity, and other derivatives totaled $1.1 trillion, including $352 billion of credit derivatives.
"This was the strongest performance on record," Mr. Brosnan said of the impressive volume. "It was a very substantive and important quarter for the banking system."
Derivative transactions frequently are agreements to hedge the risk associated with a particular element of a transaction, such as the interest rate risk on a long-term loan. When supervisors measure the use of derivatives, they look at the total value of the transactions underlying them - known as the notional value - not just the specific risk being hedged.
The previous earnings record was $3.8 billion, set a year earlier.
In the first quarter, the notional value of derivative use grew 8.3% from the fourth quarter, to $43.9 trillion. That, too, was a record.
Credit exposure blossomed in the first quarter as well. Total credit exposure, which includes current and potential future exposure, increased $63 billion, to $496 billion.
"Credit exposures showed a strong increase because volumes increased and contract mix continues to trend toward longer maturities, particularly in interest rate and foreign exchange contracts," Mr. Brosnan said. "The longer-term contracts require more capital, and this had an impact in the first quarter."
Currently, credit risk is about three times capital, he noted.
But regulators are not overly worried because banks are managing derivative portfolios well, he said. He noted that netting contracts reduced credit risk by $424 billion during the quarter. And the OCC reported negligible chargeoffs, $2 million, associated with credit risk from derivatives, or 0.0004% of the total.
Only the nation's largest banks participate heavily in the derivatives market. The seven most active banks in the business accounted for 96% of the notional amount of derivatives in the first quarter. The top 25 banks hold more than 99%.