U.S. Agencies to Require CLO Managers to Retain 5% of Deals

U.S. regulators will make investment firms or banks that create securities backed by high-risk corporate loans retain a portion of their new deals.

The final rule released today includes a requirement that managers of collateralized loan obligations ranging from Apollo Global Management LLC and Symphony Asset Management LLC hold on to at least 5 percent of the debt they package or sell. Alternatively, banks underwriting CLOs could hang on to a piece.

The rule has drawn protests from bankers and managers of the funds and would make it more expensive to put together CLOs, which have been issued at a record pace this year. Regulators are trying to curb excessive risk taking in response to the credit crisis that was fueled in part by securitized debt, particularly in the mortgage market.

“Requiring open market CLO managers or lead arrangers to retain economic exposure in the securitized assets will help ensure the quality of assets purchased by CLOs, promote discipline in the underwriting standards for such loans, and reduce the risk that such loans pose to financial stability,” regulators wrote in the document released today.

U.S. banking regulators have been separately cracking down on underwriting standards in the $800 billion leveraged-loan market, saying it’s showing signs of froth. Almost six years of near-zero interest rates from the Federal Reserve has buoyed demand for the higher-yielding debt, allowing borrowers to issue below investment-grade loans with riskier terms.

Pooling Loans

There have been $330.5 billion of new loans issued in the U.S. this year, on pace to surpass the record $357.8 billion arranged in 2013, according to data compiled by Bloomberg.

The rule pertaining to CLOs will take effect two years after being published in the Federal Register, according to the statement.

CLOs pool high-yield corporate loans, which are often used to finance leveraged buyouts, and slice them into securities of varying risk and return. The funds bought 63 percent of loans in the second quarter, according to the Loan Syndications & Trading Association, which cited Standard & Poor’s Capital IQ Leveraged Commentary and Data.

There has been $101 billion of CLOs issued in the U.S. this year, the most on record, according to Morgan Stanley.

Apollo CLO

One of the biggest funds sold so far this year was a $1.5 billion CLO raised in June by New York-based Apollo, Bloomberg data show. JPMorgan Chase & Co. arranged the deal, which consists of a $930 million slice rated Aaa by Moody’s Investors Service.

Symphony, based in San Francisco, sold a $622.5 million CLO last week that was arranged by Bank of America Corp. The fund includes a $378 million portion graded Aaa by Moody’s.

“The rule needlessly puts in place cumbersome requirements that will materially reduce the CLO market and puts in jeopardy a critical source of credit for job-creating American companies,” Bram Smith, executive director of the LSTA, wrote in an e-mailed statement today. The regulation “will negatively impact American credit markets and make financing for U.S. companies more expensive and scarce.”

Only a third of the top 30 CLO managers have sufficient capital to hold 5 percent of their existing deals on their balance sheets, according to an LSTA-sponsored study conducted by New York-based consulting firm Oliver Wyman last year based on the proposed rule.

Those managers are primarily affiliated with a large insurer or large alternative-asset manager and represented about 27 percent of the market.

The Federal Deposit Insurance Corp. developed the rule along with the Fed, the Department of Housing and Urban Development, the Federal Housing Finance Agency, the Office of the Comptroller of the Currency and the U.S. Securities and Exchange Commission. All of the regulators said they plan to approve the language this week.

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