High Concentration Of All Derivative Risk In Only Six Large Financial Firms (JPM, BAC, GS, C, MS, WFC)

Fitch has already warned today that if the United States dos not get a credible fiscal plan after the elections that it would likely downgrade the United States’ sovereign credit rating.  Now comes a scathing Fitch report on the market of credit derivatives and how highly concentrated and how large the derivatives market is.

The easy observation is that the world of financial derivatives is still way too big.  It is also far too concentrated.  Fitch is signaling that more than 75% of the derivative assets and liabilities are in only six financial companies’ balance sheets of US corporates.  This is a scary number if the sampling of the 100 largest companies across each major industry group is exact.

Fitch Ratings named the six firms as J.P. Morgan Chase & Co. (NYSE: JPM), Bank of America Corporation (NYSE: BAC), Goldman Sachs Group Inc. (NYSE: GS), Citigroup Inc. (NYSE: C), Morgan Stanley (NYSE: MS), and also Wells Fargo & Co. (NYSE: WFC).  When you hear the term too big to fail, this is one more supporting issue used to argue for the breakup of the big banks.

If you review a separate report this morning from SNL Financial, which was the concentration of the top assets and deposits at the banks, you could have any twenty of the top banks ranked #21 to #50 and they would not even equal one of the top four money-center banks.

Fitch’s report claims that the notional amount of all derivatives held by the 100 companies was approximately $300 trillion at year-end 2011. This has remained steady at between $290 trillion and $300 trillion since 2009.   The report also showed that the notional amount of credit derivatives has fallen by some 40% to $21.6 trillion at the end of 2011 from $36 trillion in March 2009.

Here is just how concentrated the derivative market is: Only 16 of the 100 companies reviewed reported exposure to credit derivatives, with the six banks accounting for 99.5% of the total exposures.  Fitch believes that the Dodd-Frank Act will make it s that non-financial firms will experience increased collateral requirements and costs to comply with new regulations as Dodd-Frank and the Volcker Rule are set to be finalized and implemented over the next two years.

As far as the systemic risks, let’s just go back to the J.P. Morgan derivative debacle from May.  This is just one case and it may cost J.P. Morgan billion before it gets out of it.  Not too many firms can absorb losses of that magnitude.  How many more big derivatives are out there which could be ticking time bombs if one of these banks got into trouble again?

JON C. OGG