At a time when the words dangerous and derivatives are frequently paired, Commercial Bank of New York stands out as a beacon of conservatism.
The bank, which was established in 1988 and has nearly $1 billion of assets, runs five branches in Manhattan and one in the Cayman Islands. The five Manhattan branches were purchased from the former American Savings Bank.
Its philosophy is simple: maintain a liquid balance sheet and keep the derivatives to a minimum. In fact, more than 60% of its assets are invested in investment-grade securities.
Commercial Bank also markets two mutual fund portfolios with nearly $140 million of assets.
Robert S. Fain, Commercial's 32-year-old vice president, said the bank strives to deliver consistent returns on its bond funds by diversification and prudent management.
"We never got caught up in the derivatives craze," he noted. "Now we look like heroes to some of our clients. We've said all along that we'd get consistent returns with asset allocation."
Mr. Fain said the key to consistent returns in the bank's bond funds is short duration. He said both funds consist of short-term portfolios of about 18 months in duration. He said the funds returned more than 8% last year.
"Most of our portfolios are in high-grade corporates, agencies, and Treasuries," he said. "Maybe a preferred stock to boost yield. It's all U.S. risk."
To hedge the risk of a declining bond market, Mr. Fain said Commercial tries to be as conservative as possible.
"We will not use derivatives," said Mr. Fain. "We manage assets on a full discretionary basis. You have to know what you are investing in. If you have an aggressive fund and you leverage up, when the market turns you will get hurt."
The book value of Commercial Bank's entire investment portfolio was $526.4 million at the end of 1993, the latest date for which figures are available.
The major component of the bank's investment portfolio was mortgage- backed securities, which totaled $390.3 million, or 72.3%, of the entire portfolio.
The off-balance sheet components of the bank's portfolio includes foreign exchange contracts, foreign currency options, and forward contracts.
The bank had $370.4 million in foreign exchange purchase contracts and $394.6 in foreign exchange sale contracts. Foreign currency purchase options amounted to $19.8 million. Standard options contracts totaled $143.8 million.
Gabriel R. Safdie, Commercial Bank's chairman, said that for the bank's own portfolio, he prefers plain-vanilla financial instruments. Exotic derivatives are nowhere to be found.
"If we make a fixed-rate loan, we'll enter into a rate swap to hedge it," he explained. "If we make a two-year loan, we'll sell two-year futures."
Mr. Safdie said it is simply too difficult to keep track of exotic hedging instruments.
"You need a staff of rocket scientists to analyze them," he pointed out. "There are a lot of hidden risks. They are monsters."
He noted that Commercial Bank's conservative approach has served well now that the market has become more volatile.
"We don't carry CMOs or IOs and POs," Mr. Safdie said, referring to securities backed by the cash flows from mortgages. "And we're pretty happy we don't have them. We're pretty conservative in our investment portfolio. Just Fannie Maes, Treasuries, and Freddie Macs."
Realizing that some of its clients may want some risk and volatility, Mr. Fain said Commercial Bank plans to introduce an emerging market bond fund later this month.
"The credit risk will be a little greater, but the payout will be higher," he said. "If our clients are going to buy these things on their own, we might as well do it for them. We can offer more protection and better yields."
Mr. Fain said the new fund will try to lessen currency risk by denominating all currencies in U.S. dollars.