Fitch: Financial Companies Hold 99.7% Of All Derivative Contracts

Tyler Durden's picture

Fitch has released a comprehensive study on derivatives held by various corporations and has come out with some disturbing results: as Zero Hedge's recent disclosure of data from the Office of the Comptroller of the Currency confirmed, the bulk of the derivative risk is concentrated not merely in the "financial company" category (99.7%) but in a subset of just five companies, which account for an "overwhelming majority" of derivative assets and liabilities.

The companies in question (Total Notional Derivatives: Assets & Liabilities, $ in Trillions)

  • JP Morgan:$81.7;
  • Bank of America:$80.0;
  • Citigroup:$31.5;
  • Morgan Stanley:$39.3, and of course
  • Goldman Sachs: $47.8 (this is an OCC estimate: Goldman has not disclosed notional amounts in their derivative book, only # of contracts);

If you want a preview of what the Basel III definition of "Too Big To Fail" will look like, the above five companies is a great place to start.

For those unfamiliar with the concept of derivatives, here is a good blurb provided in the Fitch report:

Companies use derivatives to manage risks related to interest rates, foreign currency exchange rates, equities, and commodity prices, as well as more obscure risks such as weather and longevity. According to the Bank of International Settlements, the notional amount of the global over-the-counter derivatives market was nearly $600 trillion at the end of December 2008. Furthermore, gross market value (the sum of gross derivative assets and gross derivative liabilities) stood at $33.9 trillion.

While improved disclosures and transparency are a good start to helping gauge the risks posed by these instruments, it is important for analysts and investors to take a fresh look at risk management practices, including the use of derivatives within that context.

The need for better disclosure on derivatives has been obvious since the implementation of Statement of Financial Accounting Standards (SFAS) 133, “Accounting for Derivative Instruments and Hedging Activities” (now Financial Accounting Standards Board [FASB] Accounting Standards Codification [ASC] 815). However, comprehensive derivatives disclosure did not become a U.S. GAAP requirement for most companies until March 2009 with the implementation of SFAS 161 (now ASC 815-10-50), “Disclosures about Derivative Instruments and Hedging Activities.”

For a more quantifiable overview of derivatives, we recommend the most recent quarterly report from the BIS, especially the data starting on page 28.

The key findings presented by the Fitch report are as follows:

  • Not surprisingly, an overwhelming majority (approximately 80%) of the derivative assets and liabilities carried on the balance sheets of the companies reviewed were primarily concentrated in five financial services firms: JPMorgan Chase & Co. (JPMorgan); Bank of America Corp. (Bank of America); Goldman Sachs Group Inc. (Goldman Sachs); Citigroup, Inc. (Citigroup); and Morgan Stanley (Morgan Stanley).
  • Fifty-eight percent of the companies reviewed disclosed the presence of credit riskrelated contingent features in their derivative positions. These contingent features generally require a company to post additional collateral or settle any outstanding derivative liability in the event of a downgrade of the company’s credit rating.
  • The use of credit derivatives was limited to financial institutions, with 17 of these reporting such exposure.
  • Proprietary derivatives trading by utilities and energy companies appear to be very limited, but most of the companies reviewed in both industries report the use of derivatives for hedging commodity risks.
  • Generally, non-financial companies appear to use derivatives only for hedging specific risks.
    Derivative valuation is often model-based, making changes in significant valuation assumptions particularly important. Analysis would be enhanced if issuers provided additional disclosure on the sensitivity of their derivative valuations to major assumptions.

And some charts that indicate why the Big 5 as listed above will never be allowed to go under, as the unwind of the $300 trillion in derivatives that are intertwined within their balance sheets would be end of what was previously known as free and efficient markets.

And while the gross notional value is a useful metric, in terms of actual capital it risk, it is necessary to apply a netting to the gross. Conveniently, Fitch has done the calculation. No surprise: of the Big 5, almost all (except Morgan Stanley) have a net notional exposure of over $100 billion! How about them VaR apples.

The other notable conclusion is that while virtually all non-financial companies had participated in derivative designated as a hedging exposure, it was energy companies (83%) but mostly financials (97%) that used derivatives merely as a method to speculate on underlying assets. Yet a net notional speculative exposure of almost half a trillion is staggering: this represents roughly 5% of the US GDP, the bulk of it focused on interest rate exposure. As we have speculated, in the event of a interest-rate black swan event, the fall out from the implosion of this over $500 billion in speculative derivative exposure would be enough to make the Lehman fiasco seems like a walk in the park.

It is this potential risk that these BHCs' regulator, the Federal Reserve, should be trying to mitigate, not to enhance its risk regulatory powers even more, having proven that all it does it promote increasing speculation until such time that the house of cards inevitably comes tumbles down.

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Hansel's picture

Good post again, Tyler.  Too bad nothing will change.  The outrageous size of derivatives held should cause the wind down of these TBTF banks.  Instead they will be protected by the printing press.

Anonymous's picture

BOOM

Anonymous's picture

Apocalypse Now-

And now you know the meaning of too big to fail. This is a brilliant suicide bomb that these five banks in league with the FED are wired with and have their finger on the trigger in the event that anyone tries to arrest control from them. It is the same strategy as Saudi Arabia booby trapping their oil infrastructure in the event that anyone tries to arrest control from them. This is corruption, this is where all roads lead to because of the need for DOUBLE ENTRY ACCOUNTING! ;) The other side of those entries include precious metals manipulation, interest rate manipulation, and a myriad of asset securitization schemes. This is where I would shine the light in addition to high frequency trading.

Gilgamesh's picture

That would be a most noble assignment of Project Mayhem, to start.

Anonymous's picture

Apocalypse Now-

Agreed, START HERE: http://www.occ.treas.gov/ftp/release/2009-72a.pdf

This is the most information we have on the derivative balances of each bank and their derivative classifications for all those that asked.

Anonymous's picture

Thats true... The Derivatives Market is the root off all evil. Does anyone realy know what is happening to the money supply and liquidity in case of a derivatives contraction? And how that process works in detail?

I just remember on thing Hayek said, and was cited in a Credit Suisse Paper:

„There can be no doubt that besides the regular types of the circulating medium, such as coin, bank notes and bank deposits, which are generally recognized to be money or currency, and the quantity of which is regulated by some central authority or can at least be imagined to be so regulated, there exist still other forms of media of exchange which occasionally or permanently do the service of money.
Now while for certain practical purposes we are accustomed to distinguish these forms of media of exchange from money proper as being mere substitutes for money, it is clear that, ceteris paribus, any increase or decrease of these money substitutes will have exactly the same effects as an increase or decrease of the quantity of money proper, and should therefore, for the purposes of theoretical analysis, be counted as money.“

Anonymous's picture

The total notional amount of over-the-counter (OTC) derivatives contracts outstanding was $592.0 trillion at the end of December 2008, 13.4% lower than six months earlier. The decline is the first since collection of the data began in 1998. Credit market turmoil and the multilateral netting of contracts led to a contraction of 26.9% in outstanding credit default swaps (CDS). The second half of 2008 also saw the first significant decline of OTC derivatives contracts outstanding in the interest rate market (8.6%) and in the foreign exchange market (21%)

Anonymous's picture

Mmmm...talk about clamy sweaty derranged entities with thumbs over the hole in the grenade where the pin used to be.

zeropointfield's picture
zeropointfield (not verified) Jul 29, 2009 6:28 AM

it has already gone off. the value that's in their books is the nominal value which has no basis in reality. the real value of these derivatives can be put closer, if not to, zero.

 

Anonymous's picture

What are the odds of an interest-rate black swan event when your debt is held by a bunch of Chinese bankers, the Federal Reserve ismanipulating markets and the president has the economic intelligence of a turnip?

Nah, nothing to worry about here.

texpat's picture

Auditing the Fed will easily sort out this minor snafu.
Then home in time for scones and clotted cream!

Anonymous's picture

Please - there'll be some respect shown for turnips round here

Anonymous's picture

Digging their own graves.

Cheeky Bastard's picture

You mean digging our graves

Anonymous's picture

Nope, when unemployment gets over 13%, even odds the white militia types and the black power types start taking action against the Federales. Could see a repeat of Oklahoma City, or worse.

Veteran's picture

Don't leave out the Purple Posse types, or the vicious Gang Green types 

Shamwow's picture

Don't forget about the Van Buren Boys...Know the hand sign!

Anonymous's picture

McKoys and Hatfields, cats and dogs.. oh my!

zeropointfield's picture
zeropointfield (not verified) Jul 29, 2009 6:30 AM

you forgot that those guys now have the finger on the trigger of the worlds largest nuclear, chemical and biological(!) weapons arsenal in the history of mankind.

if you think they would have a moral issue with using any of it, think again.

good luck.

Anonymous's picture

'Too big to fail and completely fucked up financial institutions' have to become 'U.S Department of Derivative and Vodoo'. There is no escaping this asteroid strike.

Anonymous's picture

The game Asteroids, yes and the targets are the shorts. The more you kill in one day the bigger your bonus

gookempucky's picture


OCC’s Quarterly Report on Bank Trading and Derivatives Activities

First Quarter 2009--link below or should we say look out below........

 

For all who do not think ZH puts enough emphasis on the amount of info per contribution you are welcome to your own reading.

This is for all you do TD

 

http://www.occ.treas.gov/ftp/release/2009-72a.pdf

 

Anonymous's picture

No wonder GS and the rest keep the robot computers squeezing shorts.

A few years ago the data today would have the dow down several hundred points and looking at reality... but now... ah who cares tis only the consumer feeling bad and they are 70% of the economy which has got nothing to do with the shoot to kill the baddie shorters game..., uh I meant stock market

Anonymous's picture

Sensational but useless. What amounts are for currency protection or interest rate protection and which are related to leveraged commodity gambling? Notional amount doesn't mean squat unless it's associated with a CDS from AIG pre crash.

Tyler Durden's picture

Which is why the net amounts are broken down. But objectively it does beg the question of who has written this $300 trillion of insurance: is it just the 5 banks playing hot potato with each other...

Anonymous's picture

I won't dispute you're smarter than I am in lots of areas. But 'notional amount' is one of those big numbers that means less than meets the eye. I have no doubt that idiots are playing idiot games again, raising prices and skimming off the top. And I have no doubt that idiot regulators know about it and close their eyes out of incompetence and fear of reprisal.

But are there any better numbers available that provide better breakdowns about the harmless vs the asinine?

I doubt they're playing hot potato with each other. Some other poor goof is holding the bag. Any ideas who?

Tyler Durden's picture

Harmless vs asinine? AIG was a beautiful example of net=gross. In an another systemic collapse you will see the same equation rear its head again - of course it will not be permitted as even $300 trillion (which is half the total outstanding OTC derivatives) is 6x the world GDP.

 

Anonymous's picture

Harmless = you and I agree to a $100 million currency swap and pay off over the fluctuation. The notional amount = $100 million. The amount you and I settle on is a lot less. This makes trillions look a lot smaller and more innocuous providing they deal with only interest rate or currency swaps or other mundane things.

Not harmless = AIG type wagering, or index futures that bang up the price of oil, or any other sure thing GS or someone else can get a fee off of. The limits of what is on the books is only limited by the imagination of the designer of the financial product, loosely used term.

But this goes back to the original point. Where's the dog shit and where's the kibble. The stats available don't tell.

Anonymous's picture

Yes and no. What we were all taught (though it seems many have already forgotten), the wild card is counterparty risk. Notional didn't mean much when LEH wents belly up.

LEH had a total balance sheet of $700 billion, yet it's failure---according to Paulson's Congressional testimony---almost brought the entire system down and had the National Guard distributing food.

LEH was a pimple on the soft underbelly of the finance industry compared to JPM, BAC and GS. Let a $2.2 trillion asset and $80 trillion notional derivative entity such as BAC go, and we go extinct.

agrotera's picture

I wonder how much of the 80 trillion came from MER?

ShankyS's picture

Ever thought that AIG is being set up to fail after they have used it as a conduit to disburse TARP funds? No wonder all those big bonuses were being paid to the morons to stay on the deck of the Titanic. The derivatives will be dumped on AIG and the music will stop and they will be the one left standing. Game over. Write 'em off. Move along, nothing happening here. 

Cheeky Bastard's picture

if you take some time and browse the net, you'd find out that the sucker still holding the bag is AIG, because most of derivatives that took AIG down were written in 2005 and 2006,and about 80% of those derivatives are 5 yrs contracts, and most of that amount had played no role in 08 when AIG came crashing down ... just do a little web search, and you will be amazed how much things have not changed, matter a fact, they became more crazy and fucked up .. so the sucker holding the bag is the same old sucker who got played in the first round of this Armageddon poker match ..

Anonymous's picture

This is such a complete gong show. NO ONE HAS ANY CLUE WHAT THIS MEANS. How does a human put $600 trillion in perspective. Its impossible. They may as well just make up a number and call it $13 gigabajillion-quintallion in derivatives. This whole game is a fucking joke. It has no where to go but down.

Cheeky Bastard's picture

doesn't really matter ... the shire amount of CDS for MBS,CMBS, CDOs etc is big enough to cause worldwide meltdown if only 10% goes bust, because the outstanding amount of those kind of derivatives is 30-35 trillion dollars, and you can expect that the amount will only go up when the hedge funds realize that another major leg down is almost certain, and they load themselves up with CDS ... and with with the up-coming bloodbath in commercial real estate, and wave adjusting of Alt-A mortgages in the next year and a half i don't find 10% bust so improbable ... so declaring this article to be sensational is pretty damn stupid ... heck if even 5% goes bust it will be worse than it was in 08

Anonymous's picture

I doubt boom.

A declaration of a firms decision not to pay a gambling debt will cast a black cloud over the firm for a year or so but then Happy Days will be Here Again and new wagers will be made, the casino will grow.

curbyourrisk's picture

They wil lower the gambling age, to get more players in the game.  They will have out free booze to get them drunk.  They will rig the game so the house always win....wait, Goldman already did that. 

 

BOOM -- BAILOUT--- RAISE TAXES -- - REPEAT

 

curbyourrisk's picture

They wil lower the gambling age, to get more players in the game.  They will have out free booze to get them drunk.  They will rig the game so the house always win....wait, Goldman already did that. 

 

BOOM -- BAILOUT--- RAISE TAXES -- - REPEAT

 

Daedal's picture

Doesn't someone have to be on the other side of the derivative contract? Are the financials betting against each other?

Cheeky Bastard's picture

in order to make my answer short: YES

Chumly's picture

 

...eating their own as we speak...more black swans on the horizon too...

Chumly's picture

 

...eating their own as we speak...more black swans on the horizon too...

Chumly's picture

 

...eating their own as we speak...more black swans on the horizon too...

Chumly's picture

I hit save once - I swear I did!

Lungless's picture

 

If you would like to find probable counter-parties to many of these derivatives , check out the holdings of Inverse, Leveraged and Inverse-Leveraged ETFs. I looked at Proshares ETFs but I suspect others may be similar. Some ultra funds seem to have a notional value of swaps about 200% of assets. Perhaps someone with more time could add up the total exposure of the ETF industry. Also lets connect the dots with the 7-27 post “The ETF Gloves Are Off”.

Anonymous's picture

Citi=US Govt./Derivatives specultors
In the words of Johnny Carson "I did NOT know that."

poydras's picture

So the financial system in aggregate is effectively unhedged.  One could easily conclude that with the limited players, contract consolidation/netting would reduce costs.  This causes one to speculate -

How many contracts have net gains on BOTH sides?

Is there another bagholder ala AIG?

 

After all this time, one should expect a competent and honest regulator to go into these outfits to determine what is going on.

Anonymous's picture

This is an excellent post. Great find, great synopsis. THIS is why I check ZH about 10 times a day.

Anonymous's picture

Any thought given to foreign institutions? Barclays, RBS, UBS, CS, DB all have fairly big derivative books as well, not to mention several asian banks. Oh yeah, BNP, SG, HSBC etc in EUR. Defining it as US exposure and banks is useless and irrelevant.

Anonymous's picture

Tyler,
Who would be the counter parties to these interest rate swaps? The Fed? The NET NOTIONAL HAS TO COME FROM SOMEWHERE>

Anonymous's picture

Actually Tyler, notional amounts of GS derivs *are* disclosed. Go to pages 24 and 26 of http://www.ffiec.gov/nicpubweb/NICDataCache/FRY9C/FRY9C_2380443_20090331...