FDIC bank balance sheets: how to interpret?

[ladelfina]

Ok, so a week or two ago when some banks were failing I decided to check out a bank I have some deposits with.

The FDIC has a site where you can compare balance sheets and reporting, here:
FDIC: Statistics on Depository Institutions

Now, I look at "MyBankcert#" compared to "Standard Peer Group"/"All Institutions".
For MyBank, it says under "Memoranda" that "derivatives" are 42% of assets.
Looking across to "All Institutions-National".. derivatives as % of assets says 1,263.78%

I don't want to be unduly alarmed, and I know "a little knowledge is a dangerous thing". What does that last number mean, and is it as -um- scary as it looks?

The site help gives this definition:

Derivatives
Represents the sum of the following: interest-rate contracts (as defined as the notional value of interest-rate swap, futures, forward and option contracts), foreign-exchange-rate contracts, commodity contracts and equity contracts (defined similarly to interest-rate contracts). Futures and forward contracts are contracts in which the buyer agrees to purchase and the seller agrees to sell, at a specified future date, a specific quantity of underlying at a specified price or yield. These contracts exist for a variety of underlyings, including traditional agricultural or physical commodities, as well as currencies and interest rates. Futures contracts are standardized and are traded on organized exchanges which set limits on counterparty credit exposure. Forward contracts do not have standardized terms and are traded over the counter. Option contracts are contracts in which the buyer acquires the right to buy from or sell to another party some specified amount of underlying at a stated price (strike price) during a period or on a specified future date, in return for compensation (such as a fee or premium). The seller is obligated to purchase or sell the underlying at the discretion of the buyer of the contract. Swaps are obligations between two parties to exchange a series of cash flows at periodic intervals (settlement dates) for a specified period. The cash flows of a swap are either fixed or determined for each settlement date by multiplying the quantity of the underlying instrument (notional principal) by specified reference rates or prices. Except for currency swaps, the notional principal is used to calculate each payment but is not exchanged.

That anything is 1200+% of assets sounds bad.

 

[twaddle]

... defined as the notional value of interest-rate swap ...

We had a thread on this a while back. I was alarmed that the size of the derivatives market was GIGNORMOUS -- many times larger than the size of our entire economy.

But it turns out that "notional" value overstates things a bit. That's the value of the underlying assets, not the actual value of the contract. Swaps aren't really levered, as I understand them.

 

[brewer12345]

Twaddle has it right. The 1200% is notional value, which is effectively meaningless.

Maybe an example will help. Supose a bank makes $1 billion in 15 year fixed rate mortgage, but all its deposits are money market deposit accounts. If short rates rise, the bank could get squeezed to death since it could eventually have to pay out more on its deposits than it earns from its mortgage portfolio. This was a major problem for S&Ls back in the day. So the smart, lower risk thing to do is to enter into a derivative that converts the 15 year fixed mortgages to floating rate paper. Nothing changes in the actual mortgage portfolio, the bank just enters into an agreement to swap fixed rate payments on $1 billion notional amount for floating payments on $1 billion notional. The only cash taht actually changes hands is the difference between short and long rates (roughly 2% a year these days, based on $1 billion, or about $20MM a year).

In the above example, the amount that would get reported as derivatives would be $1 billion. Sunds like a big scary number, but what has actually been done is to remove a large amount of interest rate risk from the bank's business.

 

[ladelfina]

ok.. I sort of understand. Thanks for your time.