Banks are seen as having an increased interest in CLOs
In a significant shift, US banks are revving up their acquisitions across various financial instruments, injecting momentum into credit markets that have experienced a slowdown over the past couple of years.
Notable players like Citigroup Inc., JPMorgan Chase & Co., and Bank of America Corp. are increasing their investments in top-tier collateralized loan obligations (CLOs), while their holdings in mortgage-backed securities (MBS) have witnessed a resurgence, as highlighted by Federal Reserve data showing a climb in 12 out of the last 15 weeks.
This surge in acquisitions by commercial banks contrasts sharply with the trend of divestment observed since March 2022, which saw Wall Street shed over $800 billion in securities. However, the tide has turned, with data compiled by Citigroup revealing a $41 billion increase in securities acquisitions by Wall Street buyers in the final quarter of 2023, effectively breaking the streak of divestment.
Banks increasing their acquisitions
According to a Bloomberg report, the resurgence in acquisitions comes amid a rise in deposits, prompting banks to seek avenues to deploy this influx of capital. With traditional lending options constrained due to subdued loan demand and increased defaults resulting from two years of interest rate hikes, banks are turning to high-quality securities as an alternative to optimize returns while managing credit risk.
Market analysts note that this renewed demand, although modest thus far, is contributing to the upward trajectory of the credit markets. Spreads on new CLOs have narrowed significantly in recent weeks, while MBS have rebounded from historically low levels. John Kerschner, head of US securitized products at Janus Henderson, emphasized the pivotal role of bank demand in driving the credit rally, predicting a sustained increase in bank investments in CLOs and MBS.
“The credit rally has multiple drivers, but an important piece of it is bank demand and we’re expecting only to see more of that,” said Kerschner.
The resurgence in bank deposits, following a downturn triggered by Silicon Valley Bank’s collapse in March, has been fueled by higher yields on savings accounts, culminating in a nearly $500 billion increase between April and December 2023, according to data compiled by Barclays Plc.
Traditionally, major banks have favored high-quality debt, such as Treasuries and agency MBS, opting to manage credit risk in their loan portfolios while mitigating interest rate risk in their bond holdings. There has been a notable uptick in agency MBS holdings, with Citigroup strategists reporting a $74 billion increase since late October. The tightening of spreads underscores the growing attractiveness of MBS, with the yield gap on newly issued Fannie Mae current coupon MBS narrowing significantly in recent months, according to data compiled by Bloomberg.
Known for bundling leveraged loans into diverse risk and return segments, CLOs are also gaining traction among banks due to their floating payouts, which offer protection against the risk of rising interest rates. Additionally, the highest-rated CLO slices enjoy favorable treatment under new Basel III capital rules, set to be finalized later this year.
“Some banks are coming to the market now looking to add CLOs for the first time,” said Ian Wolkoff, a managing director at Pretium Partners. “We think banks should have been buying CLOs earlier. The problems they faced last year might have been avoided with a higher allocation to floating rate assets.”
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