Top banking regulators in the U.S. are being urged to reconsider risk-retention rules for collateralized loan obligations on concern they would increase financing costs for speculative-grade borrowers.
BlueMountain Capital Management LLC, Invesco Ltd. and Blackstone Group LP-controlled SeaWorld Entertainment Inc. are among the more than 30 firms that wrote to the Federal Reserve, the Federal Deposit Insurance Corp. and the Securities and Exchange Commission, and asked them not to enact the rules, according to letters posted on websites of the regulators and the U.S. central bank. CLO issuance in the U.S. surged last year by 49 percent to $82 billion.
The CLO market had its most active year since 2007 in 2013, mirrored by record volume for the high-yield, high-risk loans these funds invest in, with $349.3 billion of new debt issued. The borrowings have been used to finance some of the biggest buyouts in history including the purchase of Energy Future Holdings Corp. Implementation of risk-retention rules may raise annual interest expenses faced by junk-rated companies by as much as $3.2 billion, according to a study sponsored by the Loan Syndications and Trading Association, the loan market’s main trade group.
“This shows what a big issue risk retention is to the loan market,” Ken Kroszner, a CLO analyst at Royal Bank of Scotland Group Plc in Stamford, Connecticut, said in a telephone interview about borrowers and money managers contacting regulators. “This regulation extends far beyond the CLO market; it will reshape leveraged lending.”
The proposed rule would require CLO managers to hold 5 percent of the debt they package or sell. In August regulators introduced the so-called arranger option, which would require banks to hold onto a portion of a term loan they arrange and sell to CLOs without the ability to hedge or offload it.
The regulation might reduce the amount of credit provided by CLOs by as much as $250 billion, according to the LSTA-sponsored study conducted by New York-based consulting firm Oliver Wyman and released on Dec. 18.
“It’s very clear that the CLO market will be reduced dramatically under the current proposal,” Elliot Ganz, general counsel at the LSTA, said in a telephone interview.
CLOs, a type of collateralized debt obligation that pool high-yield, high-risk loans and slice them into securities of varying risk and returns, were the largest buyers of leveraged loans in the third quarter, with a 52 percent market share, according to the New York-based LSTA.
While issuance of the funds grew last year from $55.2 billion in 2012, it fell short of the $92.8 billion 2007 peak, according to RBS. CLO sales of deals backed by widely syndicated loans plunged to $1.22 billion in 2009, the year after the collapse of Lehman Brothers Holdings Inc. precipitated the biggest financial crisis since the Great Depression, according to Morgan Stanley data.
Spreads on existing AAA CLO debt fell to 110 basis points in December from a 2013 high of 130 basis points during the first quarter, according to Morgan Stanley. They rose to as high as 725 basis points in April 2009.
Demands from CLOs and other investors allowed companies to cut interest rates on $272.4 billion of loans in 2013 as of Dec. 13, according to Standard & Poor’s Capital IQ Leveraged Commentary and Data. The average yield on loans issued by U.S. companies in December was 5.1 percent, down from 6.4 percent 12 months earlier.
Leveraged loans returned 5 percent last year, according to the S&P/LSTA U.S. Leveraged Loan 100 Total Return Index.
The Fed and the Office of the Comptroller of the Currency sent letters last year to some of the biggest banks asking them to avoid originating loans that can be considered “criticized,” or debt classified by regulatory agencies as having some deficiency that may result in a loss.
“We respectfully request that the agencies do further work on the rules and exemptions concerning CLOs, so that the final rules do not stifle our companies’ funding options,” Jim Heaney, chief financial officer of SeaWorld, wrote in an Oct. 29 letter to regulators.
SeaWorld, the Orlando, Florida-based theme-park operator that went public last year, sought a $1.4 billion term loan in May to refinance existing debt, according to data compiled by Bloomberg. The debt pays interest at 2.25 percentage points more than the London interbank offered rate, with the ability to decrease the rate based on a ratio comparing the company’s debt to its earnings before interest, taxes, depreciation and amortization, according to the data. Libor is the rate banks say they can borrow in dollars from each other.
The company has about $1.6 billion of loans, of which about $490 million are held by CLOs, according to Bloomberg and RBS data. Fred Jacobs, a SeaWorld Entertainment spokesman, declined to comment.
“Staff are analyzing the public comments and working with the other agencies,” John Nester, an SEC spokesman, said in an e-mailed statement.
Barbara Hagenbaugh, a Federal Reserve spokeswoman, declined to comment. Andrew Gray, an FDIC spokesman, couldn’t immediately comment.
More than half, about $1.2 billion, of the loans borrowed by Pinnacle Foods Inc. (PF), the Parsippany, New Jersey-based owner of such brands as Duncan Hines and Aunt Jemima, are held by CLOs, according to Bloomberg and RBS data.
Craig Steeneck, Pinnacle’s chief financial officer, wrote in an Oct. 30 letter to regulators that he is “concerned that the re-proposed rules will have adverse consequences on this valuable form of financing.” He didn’t return telephone calls seeking additional comment.
Allison Transmission Holdings Inc. (ALSN), the Indianapolis-based manufacturer of automatic transmissions controlled by Carlyle Group LP and Onex Corp., also wrote to regulators to reconsider the proposed rules.
David Graziosi, Allison Transmission chief financial officer, Christine Anderson, a Blackstone spokeswoman, and Emma Thompson, an Onex spokeswoman, didn’t return telephone calls seeking comment on the letters. Randall Whitestone, a Carlyle spokesman, declined to comment.
It’s not surprising that companies wrote letters to the regulators, Maggie Wang, head of U.S. CLO research at JPMorgan Chase & Co. in New York, said in a telephone interview. “The outstanding CLO market will shrink.”
Only about 10 of the top 30 CLO managers could hold 5 percent of their existing fund assets on their balance sheet, according to the Oliver Wyman report. Those 10 managers, which are primarily affiliated with a large insurer or large alternative asset manager, represent about 27 percent of the current CLO market.
The LSTA proposed an alternative to regulators, which would allow third-party investors, who might be holding the riskiest slices of CLOs, to be qualified as stakeholders in order to meet the risk-retention criteria.
Additionally the trade organization suggested in an October letter a category of high-quality, leveraged loans with certain characteristics that don’t attract risk retention, similar to the regulators’ development of a category of residential mortgages, QRMs, that are exempt from these rules.
More than 25 CLO managers and investors were among those market participants that wrote to the regulators asking them to reconsider the proposals.
BlueMountain, which oversaw about $17.4 billion of assets, wrote that the rule would “produce no benefits and would substantially harm competition and the public.”
Bill Hensel, an Invesco (IVZ) spokesman, and Doug Hesney, a spokesman for BlueMountain at Dukas Public Relations, declined to comment.
Under no circumstances “should any form of risk retention adopted by the agencies for open-market CLOs include the lead arranger option,” Scott Baskind, co-chief investment officer for the senior secured bank loan team at Invesco in New York that oversaw $24 billion as of Sept. 30, wrote in an Oct. 30 letter to the SEC. These proposals “are not workable in any respect and should be abandoned.”
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