WASHINGTON — Banks reported higher trading revenues while reducing credit and risk exposure in a rather "unusual" move in the third quarter, according to a report issued Thursday by the Office of the Comptroller of the Currency.
Financial institutions reported trading revenues of $5.3 billion in the third quarter, more than double the $2 billion posted in the second quarter but down 38% from a year earlier, according to the agency's Quarterly Report on Bank Trading and Derivatives Activities.
"It was a fairly robust revenue performance, given the macroeconomic uncertainties that prevailed during the third quarter," said Martin Pfinsgraff, deputy comptroller for credit and market risk, in a press release. "Notwithstanding the costs associated with relatively large, negative, valuation adjustments, trading revenues were the fourth highest on record for any third quarter."
But the more "unusual" result came from the OCC's credit risk metric — called the net current credit exposure — which fell 3% to $399 billion from the second quarter.
That was unusual because most derivatives held by banks are in interest rate contracts, which are normally very sensitive to interest rate changes, such as the current low rate environment.
"It is a bit unusual, from an historical perspective, for credit exposures to fall when interest rates fall, as they did this quarter," Pfinsgraff said.
Additionally, risk exposure fell 24% to $423 million at the five largest trading companies from the second quarter. But banks are also holding more collateral and at higher quality of collateral with 79% as cash. About 71% of their credit exposure is covered by collateral.
The OCC cautioned that results of higher revenues and lower risk on trading is really too good to be true.
The agency said higher revenues in the third quarter were due to smaller losses on credit contracts and credit trading remains "a drag on trading revenues." The second quarter also had abnormally weaker revenues due to JPMorgan Chase & Co.'s (JPM) more than $4 billion trading losses from credit contracts.
In the third quarter, banks reported $3 billion less of losses from credit trading, Pfinsgraff said. For the first time in four quarters, the notional amount of derivatives held by banks also rose 2% to $227 trillion. The previous declines were because of banks trying to reduce regulatory capital requirements and risk in their derivatives portfolio, the OCC said. A majority of this movement comes from the four largest banks, which hold 93% of the total notional amount of derivatives.
But the agency also contends that revenue results distorted actual performance since some banks hedged their valuation adjustments in credit trading and spread it across trading revenue categories.
"Declining bank credit spreads created some headwinds due to the valuation adjustments on derivatives payables and debt accounted for under fair value accounting," he said.