Credit Deriv.pdf - Quarterly Report on Bank Trading and Derivatives Activities Fourth Quarter 2019 Office of the Comptroller of the Currency Washington

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Unformatted text preview: Quarterly Report on Bank Trading and Derivatives Activities Fourth Quarter 2019 Office of the Comptroller of the Currency Washington, D.C. March 2020 Contents About This Report .........................................................................................................................1 Executive Summary .......................................................................................................................1 Revenue ...........................................................................................................................................2 Insured U.S. Commercial Banks and Savings Associations’ Trading Revenue ........................2 Holding Company Trading Revenue .........................................................................................2 Bank Trading Revenue as a Percentage of Consolidated Holding Company Trading Revenue ..................................................................................................................3 Counterparty Credit Risk .............................................................................................................3 Market Risk ....................................................................................................................................8 Value-at-Risk .............................................................................................................................8 Volatility Index ..........................................................................................................................9 Level 3 Trading Assets ..............................................................................................................9 Notional Amounts of All Derivative Contracts .......................................................................10 Credit Derivatives ....................................................................................................................11 Compression Activity ..............................................................................................................12 Centrally Cleared Derivative Contracts ...................................................................................13 Glossary of Terms ........................................................................................................................14 Index of Tables and Figures ........................................................................................................16 Appendix: Supplementary Graphs and Tables .........................................................................17 Quarterly Derivatives Report: Fourth Quarter 2019 i About This Report The Office of the Comptroller of the Currency’s (OCC) quarterly report on bank trading and derivatives activities is based on call report information provided by all insured U.S. commercial banks and savings associations; reports filed by U.S. financial holding companies; and other published data. A total of 1,324 1 insured U.S. commercial banks and savings associations reported trading and derivatives activities at the end of the fourth quarter of 2019. A small group of large financial institutions continues to dominate trading and derivatives activity in the U.S. commercial banking system. During the fourth quarter of 2019, four large commercial banks represented 85.7 percent of the total banking industry notional amounts and 83.2 percent of industry net current credit exposure (NCCE) (see tables 1 and 4 in the appendix). The OCC and other supervisors have dedicated examiners at the largest banks to continuously evaluate the credit, market, operational, reputation, and compliance risks of bank trading and derivatives activities. In addition to the OCC’s supervisory activities, the OCC works with other financial supervisors and major market participants to address infrastructure, clearing, and margining issues in over-the-counter (OTC) derivatives. OCC activities include development of objectives and milestones for stronger trade processing and improved market transparency across derivative categories, migration of certain highly liquid products to clearinghouses, and requirements for posting and collecting margin. This is the 97th edition of the OCC’s Quarterly Report on Bank Trading and Derivatives Activities. The first report was published in 1995. Please send any comments or feedback on the structure and content of this report to the OCC by email: [email protected] Executive Summary • • • • Insured U.S. commercial banks and savings associations (collectively, banks) reported trading revenue of $7.2 billion in the fourth quarter of 2019, $4 million less (0.1 percent) than in the previous quarter and $3.2 billion more (78.5 percent) than a year earlier (see table 1). Credit exposure from derivatives decreased in the fourth quarter of 2019 compared with the third quarter of 2019. NCCE decreased $57.3 billion, or 13.5 percent, to $368 billion (see table 5). Derivative notional amounts decreased in the fourth quarter of 2019 by $29.8 trillion, or 14.8 percent, to $171.5 trillion (see table 10). Derivative contracts remained concentrated in interest rate products, which totaled $125.1 trillion or 72.9 percent of total derivative notional amounts (see table 10). 1 Institutions with total assets of less than $5 billion have the option to file the FFIEC 051 call report. Due to the limited amount of derivatives data provided by FFIEC 051 call report filers, this report provides this information separately and distinctly in table 13 in the appendix. Quarterly Derivatives Report: Fourth Quarter 2019 1 Revenue Insured U.S. Commercial Banks and Savings Associations’ Trading Revenue Insured U.S. commercial banks and savings associations reported $7.2 billion in trading revenue in the fourth quarter of 2019, $4 million less (0.1 percent) than in the previous quarter and $3.2 billion more (78.5 percent) than a year earlier (see table 1). The year-over-year increase in trading revenue was primarily driven by increases in equity derivatives and combined interest rate and foreign exchange derivatives. For a historical view of quarterly bank trading revenue by instrument, see graph 9a in the appendix. Table 1: Quarterly Bank Trading Revenue, in Millions of Dollars 4Q 2019 3Q 2019 Interest rate and foreign exchange $5,133 Equity Commodity and other Credit Total trading revenue Q/Q Change Q/Q % Change $4,241 $892 21.0% $1,427 $1,805 -$378 $600 $1,109 4Q 2018 Y/Y Change Y/Y % Change $4,276 $858 20.1% -21.0% -$43 $1,470 -3387.8% -$510 -45.9% $274 $326 118.8% $34 $43 -$9 -20.4% -$476 $510 -107.1% $7,194 $7,198 -$4 -0.1% $4,030 $3,163 78.5% Source: Call reports, Schedule RI Holding Company Trading Revenue Consolidated bank holding company (BHC) trading performance provides a more complete picture of trading revenue in the banking system. As shown in table 2, consolidated holding company trading revenue of $15.4 billion in the fourth quarter of 2019 was $1.0 billion (6.1 percent) lower than in the previous quarter. The quarter-over-quarter decrease in trading revenue was driven by decreases in combined interest rate and foreign exchange derivatives and credit derivatives. Year-over-year holding company trading revenue increased by $9.9 billion (179.7 percent). For a historical view of quarterly holding company trading revenue by instrument, see graph 9b in the appendix. Table 2: Quarterly Holding Company Trading Revenue, in Millions of Dollars 4Q 2019 3Q 2019 Q/Q change Q/Q % change Interest rate and foreign exchange $6,893 $9,604 -$2,711 -28.2% $4,527 $2,366 52.3% Equity $7,388 $4,548 $2,840 62.4% $502 $6,886 1371.7% $981 $1,045 -$64 -6.1% $508 $473 93.1% Commodity and other Credit Total HC trading revenue 4Q 2018 Y/Y change Y/Y % change $158 $1,226 -$1,068 -87.1% -$25 $183 -732.0% $15,419 $16,423 -$1,003 -6.1% $5,513 $9,906 179.7% Source: Consolidated Financial Statements for Holding Companies—FR Y-9C, Schedule HI Quarterly Derivatives Report: Fourth Quarter 2019 2 Bank Trading Revenue as a Percentage of Consolidated Holding Company Trading Revenue Before the financial crisis, trading revenue at banks typically ranged from 60 percent to 80 percent of consolidated BHC trading revenue. Since the financial crisis and the adoption of bank charters by the former investment banks, the percentage of bank trading revenue to consolidated BHC trading revenue has fallen and is now typically between 30 percent and 50 percent. This decline reflects the significant amount of trading activity by the former investment banks that, while included in BHC results, remains outside insured commercial banks. More generally, insured U.S. commercial banks and savings associations have more limited legal authorities than their holding companies, particularly in the trading of commodity and equity products. In the fourth quarter of 2019, banks generated 46.7 percent of consolidated holding company trading revenue, an increase from 43.8 percent in the previous quarter (see figure 1). Figure 1: Bank Trading Revenue as a Percentage of Consolidated Holding Company Trading Revenue Source: Consolidated Financial Statements for Holding Companies—FR Y-9C (Schedule HI) and call report (Schedule RI) Counterparty Credit Risk Counterparty credit risk is a significant risk in bank derivative trading activities. The notional amount of a derivative contract is a reference amount that determines contractual payments, but it is generally not an amount at risk. The credit risk in a derivative contract is a function of a number of variables, such as whether counterparties exchange notional principal, the volatility of the underlying market factors (interest rate, currency, commodity, equity, or corporate reference entity), the maturity and liquidity of the contract, and the creditworthiness of the counterparty. Credit risk in derivatives differs from credit risk in loans because of the more uncertain nature of the potential credit exposure. Because the credit exposure is a function of movements in market factors, banks do not know, and can only estimate, how much the value of the derivative contract might be at various points in the future. Quarterly Derivatives Report: Fourth Quarter 2019 3 The credit exposure is bilateral in most derivative transactions, such as swaps (which make up the bulk of bank derivative contracts). Each party to the contract may (and, if the contract has a long enough tenor, probably will) have a credit exposure to the other party at various times during the contract’s life. With a funded traditional loan, the amount at risk is the amount advanced to the borrower. The credit risk is unilateral as the bank faces the credit exposure of the borrower. Measuring credit exposure in derivative contracts involves identifying those contracts on which a bank would lose value if the counterparty to a contract defaulted. The total of all contracts with positive value (i.e., derivative receivables) to the bank is the gross positive fair value (GPFV) and represents an initial measurement of credit exposure. The total of all contracts with negative value (i.e., derivative payables) to the bank is the gross negative fair value (GNFV) and represents a measurement of the exposure the bank poses to its counterparties. GPFV decreased by $354 billion (15.5 percent) in the fourth quarter of 2019 to $1.9 trillion, primarily driven by a $267 billion (17.1 percent) decrease in receivables from interest rate contracts (see table 3). GNFV decreased $340 billion (15.3 percent) to $1.9 trillion during the quarter, primarily driven by a $262 billion (17.4 percent) decrease in payables on interest rate contracts. Table 3: Gross Positive Fair Values and Gross Negative Fair Values, in Billions of Dollars Interest rate 4Q 2019 3Q 2019 Q/Q Change Q/Q % Change 4Q 2018 Y/Y Change Y/Y % Change $1,296 $1,563 -$267 -17.1% $1,007 $289 28.7% Foreign exchange $423 $506 -$83 -16.4% $511 -$88 -17.1% Equity $120 $115 $5 4.1% $132 -$12 -9.0% $38 $47 -$9 -19.7% $44 -$6 -13.9% Commodities Credit Gross positive fair value Interest rate $47 $47 $0 0.8% $43 $4 9.5% $1,925 $2,279 -$354 -15.5% $1,738 $187 10.8% 4Q 2019 3Q 2019 Q/Q Change Q/Q % Change 4Q 2018 Y/Y Change Y/Y % Change $1,246 $1,509 -$262 -17.4% $960 $286 29.8% Foreign exchange $431 $503 -$72 -14.4% $500 -$68 -13.7% Equity $121 $114 $8 6.6% $126 -$4 -3.4% $39 $52 -$12 -23.5% $46 -$7 -14.6% Commodities Credit Gross negative fair value $48 $50 -$1 -2.2% $43 $5 11.7% $1,887 $2,227 -$340 -15.3% $1,675 $212 12.7% Source: Call reports, Schedule RC-L A legally enforceable netting agreement between a bank and a counterparty creates a single legal obligation for all transactions (called a “netting set”) under the agreement. Therefore, when banks have such agreements with their counterparties, contracts with negative values (an amount a bank would pay to its counterparty) can offset contracts with positive values (an amount owed by the counterparty to the bank), leaving an NCCE as shown in table 4. Quarterly Derivatives Report: Fourth Quarter 2019 4 Table 4: Netting Contract Examples Bank A portfolio with Counterparty B Number of contracts Contracts with positive value to Bank A 6 $500 Gross positive fair value Contracts with negative value to Bank A 4 -$350 Gross negative fair value 10 $150 NCCE to Bank A from Counterparty B Total contracts Value of contracts Credit measure/metric Most, but not necessarily all, derivative transactions that a bank has with an individual counterparty are subject to a legally enforceable netting agreement. Some transactions may be subject to the laws of a jurisdiction that does not provide legal certainty of netting agreements, in which case banks must regard such transactions as separate from the netting set. Other transactions may involve nonstandard contractual documentation. Transactions that are not subject to the same legally enforceable netting agreement have distinct values that cannot be netted and for which the appropriate current credit measure is the gross exposure to the bank, if that amount is positive. While banks can net exposures within a netting set under the same netting agreement, they cannot net exposures across netting sets without a separate legally enforceable netting agreement. As a result, a bank’s NCCE to a particular counterparty equals the sum of the GPFV of contracts less the dollar amount of netting benefits with that counterparty. A bank’s NCCE across all counterparties equals the sum of its NCCE to each of its counterparties. NCCE is the primary metric the OCC uses to evaluate credit risk in bank derivative activities. NCCE for insured U.S. commercial banks and savings associations decreased by $57 billion (13.5 percent) to $368 billion in the fourth quarter of 2019 (see table 5). 2 Legally enforceable netting agreements allowed banks to reduce GPFV exposures by 80.9 percent ($1.6 trillion) in the fourth quarter of 2019. Table 5: Net Current Credit Exposure, in Billions of Dollars 4Q 2019 3Q 2019 Q/Q Change $1,925 $2,279 -$354 -15.5% $368 $425 -$57.3 -13.5% Netting benefit RC-R $1,558 $1,854 -$297 -16.0% Netting benefit % RC-R 80.9% 81.4% Gross positive fair value NCCE RC-R Q/Q % Change -0.5% Source: Call reports, Schedules RC-L and RC-R NCCE peaked at $804 billion at the end of 2008, during the financial crisis, when interest rates had plunged, and credit spreads were very high (see figure 2). The significant decline in NCCE since 2008 has largely resulted from declines in the GPFV of interest rate and credit contracts. The GPFV from interest rate contracts has fallen from $5.1 trillion at the end of 2008 to $1.3 trillion at the end of the fourth quarter of 2019 (see table 3). In addition, on December 31, 2 Banks report NCCE on two different schedules (RC-R and RC-L) of the call report, and the amounts reported are not the same because of differences in the scope of coverage. Neither measure comprehensively captures NCCE. RC-L includes exposure only from OTC derivative transactions; it excludes exchange-traded transactions. RC-R excludes transactions not subject to capital requirements. This report uses RC-R to measure NCCE. Quarterly Derivatives Report: Fourth Quarter 2019 5 2019, exposure from credit contracts was $47.4 billion, which is $1.1 trillion lower (95.7 percent) than the $1.1 trillion on December 31, 2008 (see table 3). Figure 2: Net Current Credit Exposure, in Billions of Dollars Source: Call reports, Schedule RC-R The bulk of NCCE in the financial system is concentrated in banks and securities firms (44.2 percent) and in corporations and other counterparties (44.1 percent) (see table 6). The combined exposure to hedge funds and sovereign governments was small (11.7 percent in total). Table 6: NCCE by Counterparty Type as a Percentage of Total NCCE Banks and securities firms Hedge funds Sovereign governments Corp and all other counterparties 4Q 2019 44.2% 2.5% 9.2% 44.1% 3Q 2019 42.2% 1.9% 9.1% 46.8% 2Q 2019 41.5% 4.3% 9.8% 44.5% 1Q 2019 43.5% 4.6% 9.6% 42.3% 4Q 2018 41.7% 5.0% 10.0% 43.2% 4Q 2017 41.7% 3.1% 7.9% 47.3% 4Q 2016 48.4% 2.0% 6.5% 43.0% 4Q 2015 53.3% 2.1% 6.0% 38.5% Source: Call reports, Schedule RC-L A more risk-sensitive measure of credit exposure would consider the value of collateral held against counterparty exposures. Reporting banks held collateral valued at 114.5 percent of their total NCCE at the end of the fourth quarter of 2019, up from 109.2 percent in the third quarter of 2019 (see table 7). Collateral held against hedge fund exposures decreased in the fourth quarter, but coverage remains very high at 485.9 percent. Bank exposures to hedge funds are secured, because banks take initial margin on transactions with hedge funds, in addition to fully securing any current credit exposure. Collateral coverage of corporate and sovereign exposures is much less than coverage of financial institutions and hedge funds, although coverage of corporate Quarterly Derivatives Report: Fourth Quarter 2019 6 exposures has been increasing over the past several years because of increases in the volume of trades cleared at central counterparties. Table 7: Ratio of Fair Value Collateral to Net Current Credit Exposure FV hedge funds FV sovereign governments FV corporate and all other counterparties FV/NCCE % 130.0% 485.9% 48.3% 91.8% 114.5% 131.8% 543.8% 49.1% 82.8% 109.2% 2Q 2019 130.9% 335.2% 47.2% 83.0% 110.1% 1Q 2019 127.7% 343.8% 48.2% 88.2% 113.4% 4Q 2018 128.9% 308.0% 47.1% 91.8% 113.7% 4Q 2017 124.4% 495.5% 25.1% 89.8% 111.5% 4Q 2016 119.1% 491.5% 34.2% 67.0% 98.5% 4Q 2015 101.6% 435.5% 15.6% 66.2% 89.6% FV banks and securities firms 4Q 2019 3Q 2019 Source: Call reports, Schedule RC-L The majority of collateral held by banks against NCCE is very liquid with 58.9 percent held in cash (both U.S. dollar and non-dollar) and an additional 13.3 percent held in U.S. Treasuries and government agency securities (see table 8). Supervisors assess changes in the quality and liquidity of collateral held as a key early indicator of potential easing in credit terms. Examiners review the collateral management practices of derivative dealers as a regular part of their supervision activities. Table 8: Composition of Collateral Cash U.S. $ Cash other currencies U.S. Treasury securities U.S. gov. agency Corp bonds Equity securities All other collateral 4Q 2019 34.4% 24.5% 11.6% 1.7% 2.3% 7.6% 17.7% 3Q 2019 35.8% 27.3% 11.0% 1.5% 1.8% 6.3% 16.2% 2Q 2019 34.9% 26.0% 12.0% 1.5% 1.9% 6.6% 17.1% 1Q 2019 34.0% 26.0% 11.9% 1.6% 2.1% 7.4% 17.2% 4Q 2018 37.2% 23.3% 10.8% 2.2% 2.1% 7.1% 17.2% 4Q 2017 37.6% 25.5% 10.3% 1.9% 2.5% 5.7% 16.5% 4Q 2016 40.1% 31.5% 8.1% 1.7% 1.6% 5.0% 12.0% 4Q 2015 43.7% 31.7% 4.6% 1.6% 1.4% 5.3% 11.7% Source: Call reports, Schedule RC-L Credit quality metrics for derivative exposures remained relatively stable in the fourth quarter of 2019, as banks reported net recoveries of $1.5 million, compared with net recoveri...
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