Yield-hungry US banks take risk on ‘sliced and diced’ securities

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US banks have increased holdings of “sliced and diced” securities to a record in the latest sign that financial institutions may be seeking to boost profits by investing in riskier, higher-yielding assets.

Growing portfolios of structured products have raised concerns that banks could be assuming more risk on their balance sheets to make up for low interest rates, a situation that would echo the pre-crisis environment in which banks created and purchased billions of dollars worth of securitised assets.

Banks’ holdings of structured products rose to almost $70bn in the three months to September, according to data released this week by the Federal Deposit Insurance Corporation.

That is a 45 per cent rise on the same period last year and the highest level since the FDIC began breaking out the individual figure in 2009.

The FDIC’s definition of the products covers a range of securitisations including collateralised loan obligations, commercial mortgage-backed securities and collateralised debt obligations.

Sales of the securities have this year surged to their highest levels since 2007, fuelled by interest from investors ranging from big pension funds to small banks and from companies seeking to refinance old loans and lock in lower rates.

Banks are also looking to offset the effect of low interest rates on their bread-and-butter lending business, analysts say.

According to the FDIC’s data, higher legal expenses at JPMorgan Chase and falling revenues from mortgage lending in the past quarter combined to create the first decline in collective net earnings for US banks in more than four years.

Banks have also been cutting back on their purchases of US Treasuries, trimming their holdings to $159bn compared with $196bn a year ago.

Regulators have voiced concerns that banks may also be increasing the “duration” of their portfolios. Investing in assets with extended maturities means higher returns but creates the risk of losses if benchmark interest rates were to jump suddenly.

The Federal Reserve revealed earlier this month that it would include a simulated sharp rise in interest rates when it next “stress tests” the largest US banks. This suggests it is concerned about potential “rate risk” in the financial system.

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