Policy Impact

Policy Impact

Regulation of the financial industry has been a consistent focus in our nation’s capital since the financial crisis in 2008. The new administration’s efforts to fix the Dodd-Frank Act has become a major priority for legislators, and any alterations to the Act will significantly impact the leveraged loan market and businesses’ access to capital.

Below you will find important information and updates regarding regulations, legislation, or other policy developments that could influence leveraged loans. Check back often to get the latest on new developments or sign up for our newsletter.

Risk Retention

The risk retention rule imposed by the Dodd-Frank Act was implemented on December 24, 2016. The rule requires a CLO manager to purchase and retain 5% of the value of any new CLO. This is akin to requiring a mutual fund manager to buy $5 of Apple stock for every $100 of Apple stock it buys for its clients. The mutual fund manager would quickly run out of money and would no longer be able to offer mutual funds to its investors.

The same is true with CLO managers. Risk retention strains the manager’s ability to continue to offer CLOs to their investors due to limited available funds, thus shrinking the amount of credit available to American businesses. Even the agencies that wrote the rule acknowledged that risk retention would shrink the amount of credit available to American businesses from CLOs.

This potential impact on the market is now a reality. According to the Wall Street Journal, new regulations on the leveraged loan market have partially caused a drop in CLO issuance, reducing available funding for businesses. CLO issuance slumped 54% from last year, meaning they are investing in fewer loans and as the article states “companies are feeling the squeeze.”

While it’s still too early to gauge risk retention’s full effects on loan issuance, legislation is already underway to improve the rule before loan availability is severely impacted.

Legislation

The CHOICE Act

The CHOICE Act would repeal and replace portions of the Dodd-Frank Act including risk retention for all assets other than mortgages. Though it is expected to pass in the House within the next few months, any legislative fix is likely to take some time.

The Expanding Proven Financing for American Employers Act – H.R. 4166

What It Does:

This bill was introduced by Representative Andy Barr (R-KY) and Representative Dave Scott (D-GA) and passed in the House Financial Services Committee by a bipartisan vote of 42-15 on March 2, 2016. While a new bill would need to be introduced into the House in this session, if passed by Congress, it would establish a Qualified Collateralized Loan Obligation or QCLO. Essentially, if a CLO meets criteria established in the six areas below, the manager would be allowed to retain 5% of the equity of a CLO, rather than 5% of the full amount of the CLO.

1. Asset Quality
2. Portfolio Diversification
3. CLO Capital Structure
4. Alignment of Interests of the Manager and Investor
5. Manager Regulation
6. Enhanced Transparency and Disclosure

This is a bipartisan, commonsense solution to risk retention that upholds the intentions and values of Dodd-Frank by ensuring managers have “skin-in-the-game” and that their interests are aligned with investors. Additionally, the QCLO would also be workable for managers who function similarly to a mutual fund manager and do not have the capital required to retain 5% of the full value of the CLO.

Recently, Lana Deharveng, a senior analyst with Moody’s, published a report titled “Qualified CLO Bill Offers Indirect Credit Positive Effects for CLOs.” According to Moody’s:

“The Barr-Scott bill’s lower risk retention requirement would significantly reduce the financial burden for managers of bringing new deals to market,” says Moody’s senior analyst, Lana Deharveng. “This would encourage new CLO issuance, thereby adding liquidity to the leveraged loan market. It would also formalize objective credit criteria for qualified CLOs, which in turn would discourage the issuance of riskier types of CLOs.

“The reduced financial burden would allow less-capitalized managers to comply with the retention rules and issue new CLOs, and could allow other managers to issue a greater number of CLOs without external financing, Deharveng says in “Qualified CLO Bill Offers Indirect Credit Positive Effects for CLOs.”

Status:

If a new CLO bill were approved by the House Financial Services Committee, the bill would then move to the full House of Representatives for a vote. Congress has a busy docket with Affordable Care Act replacement and the CHOICE Act, so it’s hard to predict when a bill will actually move to the House floor.

For updates delivered straight to your inbox, sign up for the Loans Mean Business newsletter here:


What They Are Saying

  • “While they may not have a high profile, CLOs provide a valuable function that our recovering economy cannot do without” (Floor speech during consideration of “Restoring Proven Financing For American Employers Act,” Congressional Record, p. H3257, April 29, 2014)

    U.S. Representative Scott Garrett (R-NJ)

    “[W]e should be mindful of the fact that CLOs provide financing to businesses that cannot access the debt markets affordably, if at all. For many of these companies term loan financing is their only recourse.” (Testimony before the House Financial Services Committee on behalf of the U.S. Chamber of Commerce, “The Impact of the Volcker Rule on Job Creators Part 1,” January 15, 2014)

    David Robertson, Treasury Strategies, Inc.
  • “The Barr-Scott bill’s lower risk retention requirement would significantly reduce the financial burden for managers bringing new deals to market. This would encourage new CLO issuance, thereby adding liquidity to the leveraged loan market. It would also formalize objective credit criteria for qualified CLOs, which in turn would discourage the issuance of riskier types of CLOs.”

    Lana Deharveng; Senior Analyst, Moody's

    “There has to be a revisitation of the regulation that had been introduced in the past few years about Asset Backed Securities to eliminate some of the undue discriminations toward this specific product when this product is simple, real and transparent” (Jim Brunsden, Basel Pushes Risk Realism as Draghi Prepares to Buy ABS, “Bloomberg Business,” June 11, 2014)

    Mario Draghi, President of the European Central Bank
  • “[CLOs are] an important part of the economy overall and the single-largest lender to corporations beside banks.” (Stephanie Armour, Lenders, Companies Balk at Proposed Loan Rules, “The Wall Street Journal,” November 28, 2013)

    Josh Terry, Highland Capital Management LP

    “The asset-backed market matters because it fuels lending to the real economy.” (Jody Shenn, It’s Like 2009 for Some Asset-Backed Securities Rattled by the Fed, “Bloomberg Business,” August 17, 2015)

    Jody Shenn, Bloomberg Business
  • “The reduced financial burden would allow less-capitalized managers to comply with the retention rules and issue new CLOs, and could allow other managers to issue a greater number of CLOs without external financing.”

    Lana Deharveng, Senior Analyst at Moody's

    “[T]he historic default rate of CLOs is under 1.5%, and the loss given default much lower than that. These are assets that withstood the stress of the financial crisis and continue to trade at or close to par.” (Testimony before the House Financial Services Committee on behalf of the U.S. Chamber of Commerce, “The Impact of the Volcker Rule on Job Creators Part 1,” January 15, 2014)

    David C. Robertson, Treasury Strategies, Inc.
  • “CLOs are products that help provide large amounts of credit to small businesses. They are debt securities, and they performed well through the greatest financial crisis of our time, and they continue to perform well.” (House Financial Services Committee Hearing, “The Impact of the Volcker Rule on Job Creators, Part II,” January 15, 2014)

    U.S. Representative David Scott (D-GA)

    “CLOs are important tools to expand credit availability.” (Rob Blackwell, Volcker Fix Leaves Some Small Banks Out in the Cold, “American Banker,” January 16, 2014)

    Jaret Seiberg, Guggenheim Securities
  • “We need a healthy leveraged loan market. The country needs it to finance capital investment.” (Glen Fest, Babson CEO Finke: CLOs Often Unfairly Judged, “Asset Securitization Report,” April 24, 2014)

    Tom Finke, Babson Capital Management

    “Having grown over the course of time, CLOs provide business financing to companies in 47 states and the District of Columbia that collectively employ over five million Americans. … A broad swath of corporate America participates in this market, including companies from the health care, energy, retail, entertainment, and telecommunications sectors, to name just a few.” (Testimony to the House Financial Services Subcommittee on Capital Markets and Government Sponsored Enterprises, “The Dodd-Frank Act’s Impact on Asset-Backed Securities, February 26, 2014)

    Tom Quaadman, Center for Capital Markets Competitiveness
  • “Collateralized loan obligations, or CLOs, have proven to be a critical source of funding for U.S. businesses over the last 20 years.” (Floor speech during consideration of “Restoring Proven Financing For American Employers Act,” Congressional Record, p. H3258, April 29, 2014)

    U.S. Representative Andy Barr (R-KY)

    “CLOs are primarily used by small, midsize, or challenged businesses as a non-investment grade vehicle.” (Letter to The Honorable Andy Barr, March 10, 2014)

    R. Bruce Josten, U.S. Chamber of Commerce
  • “CLOs performed extraordinarily well, yet risk retention rules don’t seem to acknowledge the fact that these securities, which performed well, helped finance more than 1200 companies that employ more than 600 million people.” (House Financial Services Committee Hearing, “The Impact of the Dodd-Frank Act and Basel III on the Fixed Income Market and Securitizations”, February 24, 2016)

    U.S. Representative Ann Wagner (R-MO)

    “CLOs represent a vital source of credit and remain an important financing resource for small to mid-size businesses across the country. Losing or restricting CLOs will make it not only harder to access capital, but it will make the loan process more expensive, ultimately reducing funds needed to build businesses and stifling future economic growth.” (Joe Dutra, Congress can help small Reno businesses with taxes, “Reno Gazette-Journal,” March 23, 2017)

    Joe Dutra, CEO of Kimmie Candy

Sign up for our newsletter

Want to keep up to date with all of our latest news and information? Enter your email below to be added to our mailing list.