‘Save the CLO’ Crusaders Make Stand as Rules Deadline Loomsby and
Dodd-Frank’s risk-retention requirements take effect Dec. 24
Critics say the regulation will crimp funding for companies
The race is on to save the biggest buyers of leveraged loans from the financial world’s endangered species list.
Less than five months remain before strict new curbs are imposed on managers of collateralized loan obligations, which purchase and repackage about 60 percent of the loans used to help fund U.S. takeovers. Sales of CLOs have already plummeted by more than half this year to $32 billion partly in anticipation of the rules, which were written in the aftermath of the 2008 financial crisis and take effect Dec. 24. After that, CLO managers such as Carlyle Group LP and Apollo Global Management LLC must retain a 5 percent stake in the products they help create -- a change that trade associations say will sap funding for corporate America.
In a battle for hearts and minds, the industry is lobbying politicians, tweeting the merits of leveraged finance on social media, encouraging companies to write letters of support, and suing regulators to soften the impact, with little success so far. Rule makers intent on squelching risks to the financial system are standing firm, and every day that passes makes a compromise before the deadline less likely.
“I haven’t heard of anyone having a lot of hope that risk-retention rules will be eradicated,” said Mike Terwilliger, a money manager at Resource America Inc. who invests in CLOs. “It’s just a matter of degree -- how bad it’s going to be.”
CLOs are assembled by managers such as Carlyle and Apollo, which buy corporate loans, including buyout debt, from banks and bundle them into securities. As recently as 2014, sales reached a record $124 billion. They’re down about 54 percent in 2016 from a year ago, data compiled by Bloomberg show.
The Loan Syndications and Trading Association -- whose members include the 10 biggest CLO managers and top arrangers Citigroup Inc., Wells Fargo & Co. JPMorgan Chase & Co. and Morgan Stanley -- is leading a campaign to loosen the rules. Representatives for those banks, Apollo and Carlyle declined to comment.
“While risk retention is esoteric, and folks don’t always see the connection to their lives, in reality, it is so consequential to the loan market, companies and the economy that of course the LSTA has spent years educating many folks on these issues,” said Meredith Coffey, LSTA’s executive vice president in charge of research and analysis.
CLOs were swept into the Dodd-Frank Act’s risk-retention rules as politicians blamed lax underwriting of structured securities for fueling the financial crisis. Opposition to some of Dodd-Frank’s provisions has grown louder in recent months, marked by MetLife Inc.’s reprieve in March from being branded “too big to fail,” which would have imposed curbs on its business.
The new rules “feel more political than necessary,” said Ted Gooden, a managing director at Berkshire Capital Corp. who advises CLO managers on mergers. “CLOs don’t pose any systemic risk.” Investors never lost money on the most senior CLO notes, according to the LSTA.
The industry is pursuing several tacks to mobilize supporters. “Loans Mean Business,” a website affiliated with the LSTA, spotlights companies it says have benefited from leveraged lending, while an associated Twitter account uses the hashtag #FinancingAmerica to link CLOs to successful summer vacations and healthy pets. The organization has also encouraged market participants to contact regulators to explain the fallout from the incoming regulations on their businesses, according to people familiar with the matter.
“The LSTA has been so involved on the topics of CLOs and risk retention because the loan market is such an important source of credit,” said Gretchen Bergstresser, a senior portfolio manager at CVC Credit Partners and an LSTA board member. “Risk retention has the potential to significantly reduce CLO formation, and by extension this would hurt the loan market and the availability of financing to U.S. companies.”
Some of the companies that have been among the biggest beneficiaries haven’t so far been engaged in the fight. Albertsons Cos., a grocery chain whose debt is the sixth-largest holding in CLOs, arranges its financing through banks and doesn’t structure loans specifically to fit into CLOs, a person familiar with the company’s financing said. The person asked not to be identified because arrangements are confidential.
Representatives for Valeant Pharmaceuticals International Inc. and First Data Corp., whose loans, according to data compiled by Fitch Ratings in June, were the biggest and second-biggest holdings in U.S. CLOs, declined to comment. Asurion Corp., ranked third, didn’t immediately respond to requests for comment.
“Borrowers are probably not very aware of who actually is out there buying their loans,” said Kevin Kendra, Fitch’s head of U.S. structured credit. “There are over 1,000 issuers that are in CLOs, so there’s a lot of CFOs out there that need to be educated.”
Bankers have won a hearing before the House of Representatives for a bill that would loosen the risk-retention standards for conservative CLOs -- those backed by senior secured loans, with significant equity buffers and that are adequately diversified among companies and industries.
If the campaign is successful, managers of “qualified CLOs” could hold a slice worth 5 percent of the CLO’s equity, rather than 5 percent of each CLO note, or equity worth 5 percent of the CLO’s overall value. That could lower capital commitments by about 90 percent. The proposal meets the letter of the Dodd-Frank law and its objectives, said the LSTA’s Coffey.
The association is prospecting for Senate sponsors, Elliot Ganz, the LSTA’s general counsel, said at a June industry conference, and his group has sued the Securities and Exchange Commission and the Federal Reserve. Representatives for both regulators declined to comment on the litigation.
“We’re trying really hard to push back,” Ganz told the conference. “The odds are extremely low, to be perfectly honest, but because the benefits are so high, we’ve been putting a lot of time into the process.”