Not many press releases get reprinted here in their entirety. But this is the Big Kahuna..the quarter derivatives trading report from the office of the Comptroller of the Currency.
WASHINGTON — Insured U.S. commercial banks and savings associations reported trading revenue of $5.3 billion in the third quarter of 2015, a drop of 4 percent or $200 million from the previous second quarter, the Office of the Comptroller of the Currency (OCC) reported today in the OCC’s Quarterly Report on Bank Trading and Derivatives Activities. Trading revenue in the third quarter was $300 million or 5 percent lower than in the year earlier period.
“It’s not much of a surprise that trading revenue fell in the third quarter,” said Kurt Wilhelm, Senior Advisor for Market Risk. “There’s a strong seasonal trend in trading revenue. It starts very strong in the first and second quarters, and then tends to tail off in the second half of the year. That’s what we’re seeing now. What is a bit of a surprise, however, is that it was weakness in revenue from trading equity contracts that caused the decline relative to the last quarter and the third quarter of 2014. Revenue from equities normally isn’t a major factor in overall bank trading revenue.”
Trading revenue from interest rate and foreign exchange products, the driver of bank trading revenue, was $4.5 billion in the third quarter, $200 million higher than in the second quarter, and $500 million higher than in the third quarter of 2014. “The stronger performance of combined interest rate and foreign exchange contracts was more than offset by weakness from equities.” Revenue from equity contracts of $56 million “essentially rounded to zero this quarter.”
For the first nine months of 2015, trading revenue totaled $18.5 billion, $300 million, or 1 percent more than in 2014. “Trading revenue in both the second and third quarters were weaker in 2015 than in 2014, so the stronger performance this year is a reflection of the very strong performance in the first quarter,” said Mr. Wilhelm. “It appears that trading revenue is slowing somewhat.”
Credit exposures from derivatives rose sharply in the third quarter. Net current credit exposure, the primary metric the OCC uses to measure credit risk in derivatives activities, increased $39 billion, or 10 percent, to $445 billion. “Concerns about weakness in the global economy in the third quarter, particularly reflected in sharp declines in equity prices in China, led to a substantial decline in interest rates. That decline caused a large increase in receivables from interest rate contracts, which drive credit exposure numbers because they are 77 percent of the derivatives market,” said Mr. Wilhelm.
The report shows that the notional amount of derivatives held by insured U.S. commercial banks declined $6 trillion, or 3 percent, during the third quarter to $192 trillion. “However, the decline is not really reflective of current activity,” said Mr. Wilhelm. “There’s still a lot of business at the dealer firms. Trade compression is simply more than offsetting normal growth.”
Trade compression was responsible for a $5.9 trillion drop in interest rate contracts, explaining the entire notional decline. On a product basis, swap contracts fell by $4.8 trillion, bringing the total swap contract decline since the end of 2013 to $40 trillion. Trade compression is a process for aggregating a large number of swap contracts with similar factors, such as risk or cash flows, into fewer trades. Compression removes economic redundancy in a derivatives book and reduces both operational risks and capital costs for large dealers.
The OCC also reported:
- Banks reported net charge-offs of $10 million, compared to net recoveries of $8 million in the second quarter. Banks hold collateral to cover 86 percent of their net current credit exposure, up from 85 percent in the second quarter. The quality of the collateral is very high, as 76 percent is cash (U.S. dollar and non-dollar).
- Trading risk exposure, as measured by average value-at-risk (VaR), moved higher in the third quarter, because of a surge in volatility. Two of the five largest dealers reported increases in VaR during the third quarter.
- Receivables from interest rate contracts increased $250 billion, or 11 percent, to $2.5 trillion, reflecting declining interest rates in the third quarter. Receivables from foreign exchange contracts increased $45 billion, or 8 percent, to $569 billion.
- Derivatives contracts are concentrated in a small number of institutions. The largest four banks hold 91 percent of the total notional amount of derivatives, while the largest 25 banks hold nearly 100 percent.
- Derivative contracts remain concentrated in interest rate products, which represent 77 percent of total derivative notional values, down from 78 percent in the second quarter, as trade compression continues to reduce interest rate notionals. On a product basis, swap products represent 59 percent of total derivatives notionals, the same as in the second quarter.
- The percentage of centrally cleared derivatives transactions increased to 38 percent in the third quarter from 35 percent in the second quarter. Clearing has developed most in interest rate derivatives, where 47 percent are cleared, and in credit derivative products. In credit, clearing is more common for investment-grade reference entities, where 21 percent are cleared, compared with 20 percent for non-investment-grade names.
- Credit default swaps are the dominant product in the credit derivatives market, representing 95 percent of total credit derivatives.
- The number of U.S. commercial banks and savings associations holding derivatives was 1,411 in the third quarter, down from 1,425 in the second quarter.
A copy of the OCC’s Quarterly Report on Bank Trading and Derivatives Activities: Third Quarter 2015 is available on the OCC’s Web site.
One critical thing to keep in mind is the continuing inflation of the money supply by the Fed – it’s up M1 and M2 are up 7.3 and 6.2% respectively in the past year.
Notional derivatives fell $5.7 trillion, or 2.9%, to $192.2 trillion, the lowest level since the third quarter of 2008. Notionals have declined in each of the past four quarters. Derivative contracts remain concentrated in interest rate products, which represent 76.9% of total derivative notional amounts. Credit derivatives, which represent 4.3% of total derivatives notionals, declined 3.4% from the second quarter to $8.2 trillion.