Flush with excess liquidity, U.S. banks are increasing their exposure to collateralized loan obligations to gain yield.
Several smaller banks have added CLOs to their securities books after reporting none in the prior-year period, and some of the nation's largest banks have added billions in CLOs over the last year. The U.S. banking industry, in aggregate, reported $120.22 billion of CLOs in their securities holdings as of June 30, up 7.7% from March 31 and an increase of 17.7% from June 30, 2020, according to data compiled by S&P Global Market Intelligence from regulatory filings. Most of the securities were classified as held-to-maturity, accounting for more than 65% of the CLO securities.
Demand for CLOs have been rising as investors seek higher yields, pushing CLO issuance to record highs in 2021, according to LCD.
More than 75% of CLOs in the U.S. banking industry remained in the hands of Wells Fargo & Co., JPMorgan Chase & Co. and Citigroup Inc.
Wells Fargo overtook JPMorgan as the bank holding company with the most CLO investments. Wells Fargo increased its CLO holdings 34.9% year over year to $33.74 billion. JPMorgan, meanwhile, pared its CLO book by $200 million over the last year, giving the bank $33.41 billion of CLOs as of June 30, down 0.6% from where it was a year ago.
Citigroup retained its No. 3 ranking in the list of bank holding companies with CLO investments. The company's holdings increased by $4.74 billion year over year, or 22.2%, to reach $26.11 billion at June 30.
The remaining member of banking's Big Four, Bank of America Corp., reported CLO holdings in its securities book of just $76.0 million, down 5% from a year ago. CFO Paul Donofrio said during the bank's earnings call that the company had taken on significantly more CLOs in its loan book, rather than its securities holdings.
"In Global Markets, we just look for opportunities to use some of our liquidity in a more constructive way than maybe buying more securities. And it was across a number of different types of opportunities in clients. But about, I would say, $6 billion-ish of it went into our decision to hold some CLOs in loan form," Donofrio said.
"Now we concentrated those holdings in AAA and AA tranches instead of distributing the securities to investors. And we think that activity is very consistent with our plans to allocate more balance sheet to customers in Global Markets. Having said all that, I know people will concentrate on CLO exposure. Our CLO exposure is still extremely low relative to our peers," Donofrio said.
Besides Wells Fargo, JPMorgan and Citigroup, the bank holding companies with CLO investments of over $1 billion were State Street Corp., Bank of New York Mellon Corp., TD Group US Holdings LLC, Stifel Financial Corp. and MUFG Americas Holdings Corp.
Several bank holding companies reported CLO balances in the second quarter after having zero CLOs in the year-ago period: Western Alliance Bancorp., Santander Holdings USA Inc., United Services Automobile Association, First Interstate BancSystem Inc., OceanFirst Financial Corp., Banner Corp. and Hope Bancorp Inc.
Western Alliance began purchasing CLOs because the floating-rate investments generate higher yields than mortgage-backed securities, and the CLOs will benefit from future increases in interest rates, the bank stated in a 2020 year-end filing. The company has been steadily adding to its CLO portfolio over the past several months, putting its holdings at $937.1 million as of June 30, all designated as available for sale.
Western Alliance's CLO portfolio consists of highly rated securitization tranches, containing pools of medium- to large-sized corporate, high-yield bank loans. These are floating-rate securities that have an investment-grade rating of single-A or better, according to a quarterly report for the period ended June 30.
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