Trump’s Team Wants to Turn Off the Safety Measures on Some BondsBy and
Proposed rules would widen exemptions from risk retention
Changes come at time when borrowing is at record levels
The Trump administration is looking to loosen post-crisis rules that force Wall Street firms to keep a portion of the bonds they create from bundles of assets ranging from subprime auto loans to leveraged corporate debt.
The rules, enacted to prevent a repeat of the 2008 financial crisis, were meant to discourage lenders from making questionable loans and leaving investors holding the bag when borrowers default. Wall Street lobbyists for years have been pushing for these rules to be softened or killed. Easing the risk-retention rules could cut funding costs for lenders and asset managers that package debt into bonds, making credit more broadly available, said the Treasury Department in a report Friday that called for a sweeping overhaul to post-crisis financial regulations.
Even with risk retention rules, credit availability in the U.S. has been booming, particularly in markets targeted by the regulations. A record $1.19 trillion of car loans were outstanding at the end of the second quarter, according to the Federal Reserve Bank of New York. Junk-rated companies have borrowed $811 billion in the loan market this year, the highest since at least 2013, according to data compiled by Bloomberg. Among small businesses that borrow often, just 3 percent reported that their credit needs had not been satisfied in the last three months, according to an August report from the National Federation of Independent Business, a trade group. That borrowing comes even after the Fed has lifted interest rates four times since December 2015, making debt more expensive.
The biggest beneficiaries of any changes to regulations may be lenders and asset managers that bundle loans into bonds. For example, smaller money managers that buy corporate debt and package them into securities known as collateralized loan obligations could find it easier to stay in business if they don’t have to come up with funding for the portion of an offering that they are now forced to keep, said J. Paul Forrester, partner at law firm Mayer Brown.
“Smaller managers who struggled to raise capital will be able to participate,” Forrester said. CLO issuance is around $85 billion so far this year, up from 2015 and 2016, according to data compiled by Bloomberg.
The Treasury Department on Friday recommended allowing lenders and asset managers that sponsor these bonds to retain fewer securities as long as the debt they are packaging meets standardized criteria to ensure its safety. While regulators had previously fashioned such exemptions, their rules for corporate loans, auto debt and commercial mortgages were too strict, according to the department. For example, car loans had to have at least a 10 percent down payment to qualify, which is high for that industry, the government’s report said.
Money managers that buy corporate loans and bundle them into bonds would be exempted from risk retention rules, because they don’t make the underlying loans, and their management fees depend on the performance of the loans, the report said.
The Loan Syndications and Trading Association, a trade group representing the market where relatively big companies borrow from multiple banks and investors, has been working on multiple fronts to loosen risk retention rules, including suing the government and encouraging its members to contact regulators to explain their complaints. It argues that risk retention regulations could sap funding from corporate America.
The LSTA’s Meredith Coffey said in an email that the group is “gratified to see that the Treasury report recognizes that CLOs are different from other forms of securitizations and recommends a form of risk retention better suited for CLOs.”
A 2011 government-appointed panel concluded that last decade, “collapsing mortgage-lending standards and the mortgage securitization pipeline lit and spread the flame of contagion and crisis.” The idea that bad incentives in the securitization markets were a key cause of the financial crisis was widely held after the housing meltdown and informed the drafting of the 2010 Dodd-Frank financial reform law. Risk retention rules that were part of that law went into effect in December 2015 for residential mortgages and December 2016 for other loan types.
Even if credit is widely available now, loosening risk retention standards could help increase credit availability even further, said Thomas Majewski, managing partner and founder of Eagle Point Credit Management in Greenwich, Connecticut, which invests in the riskiest portions of CLOs.
“Who knows how much bigger issuance would be without the regulations,” Majewski said. “You can’t say the market has shrunk, but it would probably be even bigger had the regulations not been put into place.”
— With assistance by Benjamin Bain, Lisa Lee, Charles E Williams, Claire Boston, and Lara Wieczezynski