$4 Trillion Bank Sub-Investment Grade Derivatives Now More Than Financial Crisis Peak Part 1

Posted by Doug Eberhardt on Dec 23, 2010 in Economy | 1 comment

This article analyzes the top 5 banks future problems with the over $4 trillion sub-investment grade derivatives maturing in the next 5 years, an amount that is greater than at the peak of the financial crisis.

Have we learned nothing? Did anyone in the financial media report on this?

Banks Are Not Reducing Risk, But Taking On More

There are over $600 trillion reported derivatives, most representing normal business activity by companies to control their cash flows. U.S. commercial banks hold about $235 trillion of these derivatives, of which just five hold 96%% of the industry net current credit exposure.

In the first quarter of 2010, the notional value of derivatives held by U.S. commercial banks increased $3.6 trillion. In the second quarter they rose by $6.9 trillion with credit exposure from derivatives increasing and the latest quarter ending in September, U.S. value of derivatives increased by $11.3 trillion while revenues decreased by 27% compared to 2009. Credit derivatives increased another 4.3%. during the quarter.

4 Trillion of Sub-investment Derivative Problems Maturing In Next 5 Years

The Office of the Comptroller of the Currency (OCC) comes out with a quarterly report called OCC’s Quarterly Report on Bank Trading and Derivatives Activities. This report gives the current bank derivative trading activity.

The nations top 5 banks are still facing sub-investment grade derivative problems, 4 trillion of which will mature in the next 5 years, up from 3 trillion after the end of 2009.

I first reported this risk in my book, Buy Gold and Silver Safely where I showed the following chart from the OCC (source – for better image viewing):

You can see from this chart that the top 5 banks had just over $3 trillion in sub-investment grade derivatives maturing in the next 1-5 years with all commercial banks combined totaling 3.2 trillion coming due.

Fast forward to the third quarter of 2010 and we see that the top 5 banks have increased their sub-investment grade derivatives maturing in the next 1-5 years by $1 trillion to just over $4 trillion according to the latest OCC quarterly report (source for sharper image):

Citibank was the biggest mover, with HSBC replacing Wells Fargo in the top 5. Also note that the sub-investment grade maturities of one year or less increased by $178 billion since the end of 2009, and longer term maturities of over 5 years increased by $300 billion in the sub-investment grade category. All maturities in this category saw an increase of 1.28 trillion derivative exposure in just the last 9 months.

J.P. Morgan leads all banks with over $1.89 trillion of sub-investment grade maturities of 5 years or less. After the Panic of 1909, J.P. Morgan himself was the bank, deciding who would get loans and who wouldn’t. It seems that things haven’t changed with his namesake.

If these numbers don’t do anything to frighten you, look no further than what the derivative situation was at the peak of the financial crisis of 2008-2009 when banks were in dire need of cash. These banks presently have more sub-investment grade credit derivatives on the books than they had at the peak of the financial crisis, besting that figure by $500 billion.

If the banks were in crisis mode in 2008 and 2009, and have even more exposure to credit risk today, what does this mean about their future?

Continue to Part 2

Just Who Will Be the Counterparty to These Credit Derivatives?

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• $4 Trillion Bank Sub-Investment Grade Derivatives Now More Than Financial Crisis Peak Part 2
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