By Ashley Lau
NEW YORK, Nov 14 (Reuters) - BlackRock Inc, a moneymanager that has long worked with the largest U.S. financialinstitutions, is now turning to the country's smaller banks,where it sees a promising market for exchange-traded corporatebond funds.
The roughly 7,000 regional and community banks across thecountry have securities portfolios totaling some $1.5 trillion,a majority of which are in mortgage-backed securities, accordingto BlackRock's own estimates.
That concentration might make them more vulnerable tointerest rate risk. While all bonds get hurt when rates rise,mortgage bonds feel it more than other sectors, and regulatorshave been pressing banks to dial down their interest-rate riskby lightening up on these securities and investing elsewhere.
To BlackRock, that looks like opportunity.
"This is going to be a multiple-year trend and dialogue,"said BlackRock managing director Jared Murphy, who is overseeingthe effort to extend the ETFs.
Called iSharesBonds ETFs, the funds feature 100 to 200investment-grade corporate bonds and a low-cost expense ratio of0.1 percent. Each fund's underlying securities have a definedmaturity designed to reduce interest rate risk. On a datecertain, investors will know the bonds in the ETF are worththeir full face value.
BlackRock won its first big convert last quarter when a westcoast regional bank invested $100 million in one of the funds.Since the products launched in April, BlackRock has hadconversations with more than 150 regional and community banks.
But some analysts said BlackRock could have a hard timeselling the product. When smaller banks reduce their mortgageexposure, they are more inclined to buy Treasury securities,which essentially have no credit risk, instead of corporatebonds that can default.
"Community bankers feel like they're going to be the last inthe food chain to know if there are any problems with acorporate issuer," said Edward Krei, managing director at theBaker Group, an Oklahoma City-based consulting firm that advisescommunity banks.
To the extent that banks do take credit risk in theirsecurities portfolios, it is generally confined to municipalbonds, Krei said.
The smallest of the community banks, with $5 billion or lessin assets, had less than 5 percent in the category that includescorporate securities at the end of the last quarter, accordingto U.S. financial data provider SNL Financial.
They had roughly 42 percent of their portfolios inresidential mortgage-backed securities, and another half splitbetween Treasuries and munis.
Guggenheim Investments has a similar lineup offixed-maturity ETFs, called BulletShares, that are made up ofhigh-yield corporate bonds. Each fund targets a differentmaturity date, much like the iSharesBonds suite. It has not visibly marketed the ETFs to small banks, anddeclined to comment on that for this story.
REGULATORS ASK FOR DIVESTMENT
Earlier this year, the Office of the Comptroller of theCurrency warned that increased holdings of mortgage-backedsecurities by banks with less than $10 billion in assets, "maymake some institutions more vulnerable to interest-rate risk."
Regulators also require banks to assess the credit qualityof the securities they hold, so BlackRock turned to its riskanalytics division to provide credit monitoring.
"This is particularly important in the bank channel," saidChicago-based Morningstar analyst Ben Johnson, adding that, byincluding analytics, Blackrock increases its chances with smallbanks.
Big banks already have the resources to hire in-house teamsto do credit quality research on securities, and BlackRock mighthave a leg up on later competitors because it is getting therefirst with robust credit analytics, Johnson said.
But the ETFs do not absolve bankers of all theirresponsibilities and headaches. The accounting treatment thatbanks usually choose for securities investments means thatchanges in the value of assets affect the balance sheet, even ifthey do not affect earnings.
BlackRock is "making it easy" for small banks to getcorporate debt, but that might not be enough to win bigbusiness, suggests Jim Reber, president of Memphis-based ICBASecurities, a subsidiary of the Independent Community Bankers ofAmerica that sells securities to member banks.
"If (a bank) doesn't want to have exposure, there's noamount of ease of entrance into that market that is going tochange their mind," he said.
Murphy remains undeterred. With total assets in the funds atjust north of $350 million, he hopes to grow the business to$500 million by year-end. This includes sales to other clientsand bigger banks that might simply use the ETFs for easy andinexpensive corporate exposure. He aims to make it amulti-billion-dollar business over the next few years.
The bank client segment right now is just a small slice ofBlackRock's larger iShares business, which it acquired fromBarclays in 2009. The iShares unit, the largest U.S. ETFbusiness, accounts for roughly 30 percent of BlackRock's totalrevenue.
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