New CLO Regulations May Lead to Issuance Slump, Wells Fargo Says

Issuance of collateralized-loan obligations, the biggest buyers of leveraged loans, may decrease after the implementation of new regulations, according to Wells Fargo & Co.

Fewer managers will be willing to sell CLOs after the establishment of risk-retention rules, spurring volatility, and will leave behind a vacuum that can’t be filled by other investors, Dave Preston, a Wells Fargo analyst, wrote in a Sept. 20 report. CLO formation may increase before the rules take effect in late 2015 or early 2016, the report said.

The requirement that CLO managers hold a portion of the debt they package and sell, proposed as part of the regulatory overhaul mandated by the Dodd-Frank Act, will drive up capital requirements. Issuance of CLOs has climbed to more than $61 billion this year, JPMorgan Chase & Co. said in a Sept. 20 report.

The market for CLOs, which had disappeared after the onset of the financial crisis, has been revived with sales of more than $110 billion in the last two years, according to Wells Fargo. CLOs purchased 53 percent of leveraged loans in the second quarter, according to the Loan Syndications and Trading Association.

CLOs are a type of collateralized debt obligation that pool high-yield, high-risk loans and slice them into securities of varying risk and returns.

The increased purchase by retail funds will result in more volatility in the loan market, Preston wrote.

Investors have added $53.7 billion this year to funds that purchases leveraged loans, increasing the pool of cash managed by the funds by more than 71 percent, Bank of America Corp. wrote in a Sept. 19 report.

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