It’s no secret that banks are big buyers of collateralized loan obligations, but a report published this week by SNL Financial sheds some light on the appeal of these structured products to lenders.

In some cases, it’s not just the attractive yield or familiarity with the asset class, but a desire for exposure to the commercial loans backing these securities.

Banking industry holdings of collateralized loan obligations have risen sharply in the wake of the financial crisis. Since the first quarter of 2010, banks and thrifts have grown CLO balances by close to 135% as of the first quarter of 2013, according to SNL. CLO holdings as a percentage of banks' total securities have climbed more than 75% over the same period.

First Niagara Financial Group Senior Executive Vice President and CFO Gregory Norwood told SNL his firm has increased its holding as part of its acquisition strategy when it purchased 195 HSBC USA branches. "Since we didn't buy a lot of loans with that acquisition, we wanted to buy credit assets that began to mimic the assets we would have bought," he said.

First Niagara's CLO balance jumped to nearly $1.6 billion, or 13.14% of the bank's total securities, in the first quarter of 2013, compared to $800.1 million, or 5.52% of total securities, in the first quarter of 2012.

Norwood told SNL the company does not have plans to continue upping its CLO balance. "We basically have the book we want and it will amortize down over time and loans will grow, and you'll see that balance sheet rotation from securities into loans," he said.

First Niagara is one of several companies that have ramped up their CLO balances in recent quarters. According to SNL data, 21 of the 28 U.S. banks and thrifts that held CLOs at March 31 have increased their CLO holdings since the first quarter of 2012.

At Goldman Sachs Group, for example, CLO holdings rose to $949.0 million at March 31, compared to $279.0 million in the first quarter of 2012. Morgan Stanley increased its CLO balance to $677.0 million at March 31, from no holdings in the prior-year period. JPMorgan Chase, Wells Fargo, Citigroup and Bank of America have also increased their CLO balances since the first quarter of 2012.

It’s not just big banks that have added to their holdings. After holding no CLOs in the fourth quarter of 2012, Greenwich, Conn.-based Fieldpoint Private Bank & Trust's CLO holdings jumped to $20.3 million, or 10.87% of total securities, at March 31.

Bill Kennedy, chief investment officer at Fieldpoint Private, said the numbers reflect a concerted effort to manage risk in the company's portfolio. "The management team worked last year to try to find opportunities where we could reduce our interest rate risk and our duration risk, and take a little bit more credit risk and liquidity risk in the portfolio," Kennedy told SNL. He said duration risk posed an increasing threat in summer 2012, driving the company out of long-dated paper like Treasurys.

Like the syndicated loans used as collateral, securities issued by CLOs are floating rate.

"We felt CLOs were an area where there might be some opportunity, if we could get comfortable with the structure, get comfortable with the issuer, the custodian, and of course, the underlying credit exposure," Kennedy said. "We thought: Here's an opportunity to pick up some yield at a floating-rate instrument and shift that risk exposure away from duration to more of the credit side."

Like First Niagara, Fieldpoint Private will not necessarily be continuing to increase its CLO holdings, however: Kennedy noted that 2013 has been a very robust year for new issuance in the CLO space. "That's not always a good sign. The issuance [tends to] go wherever the capital is available," he said. "The deeper the new issuance market becomes, the harder it is to identify the really good credits, those diamonds in the rough."

Kennedy also noted that spreads have been tightening. "Spreads on everything have contracted …CLOs to boot," he said. "As we got into the first quarter of this year, and even this quarter, we've seen that stretch for yield accelerate.”

Neither Kennedy nor Norwood discussed another possible reason not to add further to CLO holdings: a change in deposit insurance rules that took effect on April 1. Assets now factor heavily into calculations of deposit-insurance premiums, and the rules require higher assessments for even the least risky CLO tranche, those rated ‘AAA.’

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