U.S. banks, spurred by a federal regulatory change, will be encouraged to buy the riskiest pieces of a type of structured credit product or exit the investments altogether, according to Fitch Ratings.
JPMorgan Chase & Co. (JPM:US) and Wells Fargo & Co. (WFC:US) are among the biggest investors in collateralized loan obligations, or CLOs, which bundle speculative-grade loans into securities of varying risk. Since April 1, the Federal Deposit Insurance Corp.’s method for calculating premiums has assigned a higher cost to all CLO investments, from the safest to the riskiest.
Banks are grappling with the change in how the FDIC calculates their deposit insurance premiums, funds that are used to repay account holders if a lender fails. Banks that choose to keep investing in CLOs may stick to the riskier slices instead of the AAA-rated portions because they offer greater returns, Fitch said in a statement.
“The FDIC is trying to keep ahead of any emerging risk related to CLOs,” Joo Yung Lee, head of Fitch’s North American financial institutions group, said in a phone interview. “Their general intention is to keep it simple and have an assessment for higher capital charges for what they view as a riskier potential asset class.”
U.S. banks owned $56.6 billion of CLOs at the end of March, up 24 percent from a year earlier, according to Fitch. Fitch cited data from Thomson Reuters Corp. unit Highline Financial.
JPMorgan, the biggest U.S. bank by assets, owned about $27.3 billion of the CLOs, Fitch said. Wells Fargo, the fourth-biggest, boosted its holdings of the securities to $15.3 billion, up 90 percent from a year earlier. No. 3 Citigroup Inc. (C:US) had $4.5 billion, Fitch said.
Large regional lenders and some “very small” institutions also have increased their investments in CLOs to help compensate for narrower net interest margins, Fitch said. That’s the difference between the interest a bank pays on deposits and receives on loans.
PNC Financial Services Group Inc. (PNC:US), the second-biggest U.S. regional bank, boosted its investments in the products to $2.1 billion at the end of March from $323 million a year earlier, according to Fitch.
The FDIC, led by Chairman Martin Gruenberg, crafted the rule as part of the financial overhaul mandated by the 2010 Dodd-Frank Act. Changes in banks’ CLO investments could show up when the companies report second-quarter results, Fitch said.
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