Deutsche Bank AG is planning to follow the lead of a number of U.S. banks and invest in senior-most CLO tranches as a way to better manage excess liquidity and boost profitability.
The bank in recent weeks was a buyer of a AAA CLO tranche with a shorter reinvestment period that was also structured to comply with risk retention rules in the EU, a number of sources said. Going forward, the bank’s purchases will continue to be focused on shorter-duration CLOs, sources added. A spokesperson for Deutsche Bank declined to comment.
More broadly, Deutsche Bank is targeting assets with a spread of 100 bps or higher and a three-year average life, Stuart Graham, head of Banks Strategy at Autonomous Research, said in regard to the bank's overall strategy. While not naming corporate debt or CLOs specifically, Graham mentioned the senior tranches of commercial real estate securitizations and asset-backed securities as some of the targeted assets in the bank's treasury portfolio.
Asset purchase program
Senior management at Deutsche Bank first outlined its intention to shift more of its liquidity reserves into securities toward the end of last year. Deutsche most recently reported liquidity reserves of around €260 billion, or a liquidity coverage ratio of 141%, in April.
"In the first quarter we deployed approximately €5 billion of our liquidity reserves into higher-yielding assets," Treasurer Dixit Joshi said during the earnings conference call. Joshi added that Deutsche Bank intends to deploy another €20 billion in the coming quarters.
READ MORE: Those $700B in US CLOs: Who holds them, what risk they pose
Excess reserves that get held in cash are particularly punitive for European banks as the deposit rate at the European Central Bank (ECB) is currently –0.4%, a rate that the ECB recently has hinted could move even lower, though mitigants such as a tiered-rate system could be put into place, similar to Switzerland and Sweden.
As previously reported, several other banks have been active buyers of senior CLO tranches, including Wells Fargo with $34.6 billion, J.P. Morgan with $20.4 billion, and Citi with $18.1 billion in CLOs, according S&P Global Market Intelligence.
A handful of Japanese banks facing declining net interest margins and a shrinking pool of domestic securities, by which they can hit their target yields, have also become prominent buyers of the AAA tranches of CLOs.
The notion of banks growing their exposure to three-letter securitizations can cause consternation among policymakers and regulators, but unlike the similar sounding CDOs, the AAA tranches of CLOs, where the banks have concentrated their purchases, have yet to take a single cent of principal losses, even during the financial crisis.
"We think we can generate 50 to 100 bps of additional yield without taking really a significant risk and certainly within our risk appetite," Deutsche Bank Chief Financial Officer James von Moltke said in reference to expanding investments into higher-yielding assets broadly, during the Oct. 24, 2018, earnings call.
This analysis was written by Andrew Park, who covers CLOs for Leveraged Commentary & Data (LCD), an offering of S&P Global Market Intelligence.